FX Briefing

Highlights

• US Fed willing to resort to unconventional monetary policy measures
• ECB, BoE and Swedish Riksbank make further interest rate cuts
• Pound falls to new lows, burdened by aggressive easing

ECB Tight-lipped

This week has brought bad news on the economic front, especially from the US, but the main focus has been on further interest rate cuts. Central banks in industrialized countries are lowering their key interest rates drastically in an attempt to combat the constraints in financial markets and improve financing conditions for companies and private households. On Wednesday night, the Reserve Bank of New Zealand cut interest rates by 150bp to 5%; the Swedish Riksbank followed suit on Thursday morning by slashing interest rates by 175 bp to 2%. Then at midday, the Bank of England lowered the bank rate by 100 bp to 2%, and finally, half an hour later, the ECB cut the refi rate by 75 bp to 2.5%.

Even central banks which no longer have much scope to cut interest rates are taking action too: at the beginning of the week, the Bank of Japan agreed in an extraordinary meeting to accept lower-rated corporate bonds and loans as eligible collateral. But a particularly striking announcement came from the Fed: Fed chairman Ben Bernanke indicated that, as well as using conventional interest rate policies to support the economy, the Fed was also willing to resort to unconventional measures. He was referring on the one hand to measures open to the Fed to influence longer-term interest rates, such as purchasing long-term Treasuries or committing itself to keeping interest rates low. But on the other hand there was also the option of "intervening" in certain market sectors to improve market conditions for investors and issuers. In this connection, he pointed out recent measures like the purchase of securities and MBS issued by governmentsponsored mortgage lenders such as Fannie Mae and Freddie Mac, and the facility for purchasing ABS collateralized by consumer loans.

The ECB did cut key interest rates by a further 75 basis points, which was more or less what markets were expecting. But whereas the Fed is pulling out all the stops, the ECB seems hesitant and indecisive. The ECB staff growth projection forecasts distinctly weak demand until well into the year 2010, but the Governing Council sees inflation risks as being "more balanced than in the past", i.e.: not yet balanced. And at the press conference, ECB president Jean-Claude Trichet made no mention whatever of future monetary policy intentions, pointing out instead that by cutting interest rates by a total of 175 bp within a few weeks, a lot had been done already. Furthermore, he said the Council had "reached the decision to reduce interest rates by 75 bp by consensus", which suggests that some Council members might have been happier with a more leisurely pace. In a newspaper interview after the meeting, ECB Governing Council member Yves Mersch, for instance, stated that rates would not be cut by such big amounts in the future.

In view of the indecisive signals from the ECB and the long rally beforehand, bond and money markets have corrected since the meeting. The interest rate differential between the eurozone and the US, where interest rates are expected to be cut to 0.5% on 16 December, has widened. This has boosted the euro: EUR-USD rose over 1.28 temporarily. However, we are expecting the rate cut process in the eurozone to continue. German industrial new orders plummeted again – they are now over 17% below last year's level; but this is only one of many signs that the eurozone is falling deeper into recession. The ECB will be forced to take further action sooner rather than later. We therefore expect EUR-USD to move back into the lower end of the trading range of the last few weeks shortly.

The same action taken by two different organizations, does not necessarily have the same effect. The forex market seems to be rating the US Fed's extremely expansive monetary policy much higher than comparable efforts made by the BoE. In the space of less than two months, the UK central bank has cut key interest rates by 300 basis points to 2%, signalled that further cuts are on the cards, and indicated possible cooperation with the Treasury, i.e: quantitative easing by means of direct purchase of government bonds. At any rate, the forex market's reaction to all this was somewhat allergic: cable fell below 1.45 at times, EUR-GBP rose to a new high of 0.8726. With regard to EUR-GBP in particular, we see further risks ahead.

BHF-BANK
http://www.bhf-bank.com

This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHFBANK Group") solely for the information of its clients.

The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results.

This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities.

This publication must not be distributed in the United States.