ECB, Bank of England and Bank of Canada

ECB: July 5 at 11:45 GMT
The European Central Bank will keep rates on hold at 4% but the markets will be listening intently to the MPC President – Jean Claude Trichet, for any signals that rates will be raised in forthcoming months. Markets expect a rise in rates to 4.25% in September, with one more rate increase before the end of the year, to bring the underlying rate for the euro group of countries to 4.5%. ECB members have been decidedly hawkish of late and with oil prices back over $70 a barrel, it will be a surprise if Trichet does not point to price stability risks in the medium term. The Bank should retain its 'accommodative’ policy and reiterate that interest rates remain ‘moderate.’ Despite the fact that inflation has been held below the Bank’s target 2% level all year, the euro zone economy is expanding at a higher rate than forecast and with this week’s manufacturing and services indices revealing increased expansion in June, the MPC will certainly feel the economy has plenty of scope for further monetary tightening. While retail sales have faltered in recent months, employment numbers across the zone have hit new highs and the Bank foresee increased spending in the second half of this year. Trichet should signal on Thursday a rate hike to take place within the next two months and markets should be left with an impression of 1 further rate hike this year. Anything less could send the euro into retreat.

BoE: July 5 at 11:00 GMT
This is difficult to call because of the vote at the last MPC meeting in June, when the Governor found himself in a 5-4 minority - the committee voted to keep rates on hold. Since that meeting we have seen a series of weaker inflation data, although there appears to be little letup in the rise in house prices. Hawks on the Board will be helped by some recent economic data, where we saw quarter one GDP revised upwards to 3%, further tightening in the employment sector and a widening in expansion in the country’s services sector. With markets expecting rates to climb at least twice more, the hawks will be trying to force home a rate rise this month and will see no point in waiting until August. The result will depend on the hawks being able to bring at least one of the doubters over to their side on Thursday. Governor King irresponsibly intervened in the debate the day before the UK consumer price inflation data for June was released a few weeks back, when the timing of his blatant call for further rate rises biased the market's response to actual data. This had the impact of elevating the country’s currency and keeping it there, despite the fact that consumer prices the next day reported a sharp decline in the annual inflation rate from 2.8% to 2.5%. If the MPC fail to approve a rate rise Thursday, Governor King’s authority and influence will be seriously undermined again and he may rightly find himself in an untenable position. The lack of direction and consensus from the Bank of England over the past 12 months has been startling to say the least and this Thursday could be another day when the MPC does not cover itself in glory. Of course we will not know what exactly transpired for 2 weeks, when the minutes of the meeting are released. There remains a very good chance that rates will not rise this Thursday as it makes sense for the MPC to wait until August, when the Bank's quarterly inflation report is due to be released. The reasons for voting against a rate rise in June still hold true in July and with the MPC not having access to the latest consumer price inflation data (it is not released until July 16), it makes sense to wait. It will be a close run thing, that is for sure, but whichever way it goes, it could prove to be another uncomfortable day for the Bank’s Governor – Mervyn King, who has failed miserably to exact any meaningful influence over this particular MPC.

BoC: July 10 at 13:00 GMT
The Bank of Canada has an unenviable task ahead of them next Tuesday, having all but signalled to the markets in their statement at the end of May that a rise in interest rates was a near certainty. The Bank made a cardinal error by showing their hand too early, because it came at a time when the Canadian dollar was appreciating at unprecedented levels and came before the country’s latest inflation data release (for May) which subsequently saw a decline in both the country’s headline and core inflation rates. Since the beginning of June economic data out of Canada has been less than impressive, with lower than expected gains in employment, manufacturing output falling, retail sales slowing significantly and growth flat into quarter 2. Despite this, the Canadian dollar has been appreciating to new 30 year highs against its US counterpart, as speculators bet on 2 or more rate rises from the country’s Central Bank and trade the currency like it was a commodity. There are plenty of arguments for why the Bank should keep rates on hold this month, but the fact they have already signalled to markets that rates ‘may’ rise, means they will probably have to make good their promise and proceed with a 25 basis point hike this month. The Bank has quite a complex procedure for determining monetary policy, and the whole process begins this Friday, with the decision only announced next Tuesday. The Bank chose to refrain from commenting on the value of the Canadian dollar in its last statement, which was another mistake, as it in effect gave license to speculators to push the currency higher and higher, even against a background of softer data. The Bank would do well to look at the experience of the RBNZ that made a failed attempt to rein in the currency – after having raised interest rates there to levels that were going to cause serious problems for the currency. If the Bank of Canada go ahead with a rate increase next Tuesday, as expected, and leave the door open for possible future rate rises, then they will have lost control over the direction of the country’s currency. The dependency of Canada’s economy on the US market is enormous, but the overvalued Canadian dollar may ultimately prove to be the economy’s downfall and the impact may be seen sooner rather than later and subsequently lead to a reversal in monetary policy.

Central Bank Watch - ECB and Bank of England

ECB (June 6)
There is little doubt but that the ECB will hike rates for an eight time in 18 months, when they meet this Wednesday, to bring the euro zone’s base rate to 4%. The real issue concerning markets is what will happen to euro rates thereafter. The ECB’s Weber was quoted last week as having said the ECB would refrain from using code words to signal future rate hikes, so we expect a new approach from Jean Claude Trichet in his post announcement press conference this week. Economic data from the eurozone is holding up positively, despite the recent rate rises, so the Bank could justify continuing a hawkish line if it so chooses. It is likely that no further rate hike is on the agenda until at least September, so the ECB may decide to kick the issue to touch and adopt a ‘data dependent’ wait and see approach over the coming months. The MPC will justifiably feel vindicated by their policy strategy as the euro area economy continues to grow impressively, while inflation has firmly been held below 2% since last summer. The most likely outcome Wednesday, is for a hawkish Trichet to keep markets guessing, but appearing hawkish enough for markets to price in one more rate hike after this week. Anything short of a stern warning on price stability/inflation will be perceived as a softening in stance and if the MPC are seen to be backing off, then the euro could be in for a prolonged retreat over the summer months.

BoE (June 7)
Last month’s MPC minutes sent the market into a tizzy, with the unanimous 9-0 vote for May’s hike seen as a slant towards further tightening, possibly as soon as this month. Sterling has advanced on the increased rate prospects but the reality is that the Bank is almost certain to keep rates on hold this week and issue no statement on their deliberation Thursday, thus keeping markets guessing and most likely sending sterling backwards. The Bank will however have sight of May’s CPI data (not published officially until June 12) and if this reveals an inflation climb to over the 3% rate from last month’s 2.8% rate, there remains a remote outside chance of a hike this week. The minutes from the Bank’s last meeting reveal an MPC who are as unsure as to the direction of inflation and thus interest rates as the rest of us. Mervyn King, and by association the MPC, keeps referring to market expectations for where interest rates will be at later this year - in effect telling us the MPC does not have a consensus opinion of its own. The smart money is for one more rate hike, probably in August, but with UK data very much mixed of late, the prospect of no further UK interest rate hikes is also beginning to become a possibility. With the MPC unable to offer any intelligent insight, it is left to the market’s own devices to interpret the economic data as it is released, and what it may mean for interest rates going forward. The first instalment in this regard is not due until next week, when May’s consumer price data is released.

Market Watch: Canadian Dollar

As we speak, the Canadian dollar has hit a low (1.5590) against the euro not seen since May 2005. Although the Canadian economy hit a rough patch in the latter half of 2006, the economy has shown strong signs of recovery this year, with economic fundamentals reflecting a marked improvement thus far in 2007. In the most recent economic outlook report from the OECD for developed nations, Canada was the only economy of the leading nations that was seen to expand in the coming months, with a general slowdown being forecast for the wider group. Commodity prices, important to Canada’s corporate coffers, have rebounded in the past 2 months and Canada’s burgeoning trade surplus and massive energy reserves make it the envy of rest the world. Employment is flourishing and the Canadian construction sector has been booming, unlike in the US. So why is the country’s currency behaving like that of an emerging country, at the wilful mercy of currency speculators?There are a number of factors / reasons:

1) Trends. The Canadian dollar has been on a downward trend across the board since last summer, a decline that sharpened from October through to the end of the year. In the past year alone, the loonie has lost 14% of its value against the euro. That is a remarkable downward slide and the problem with long-run trends is that they are difficult to reverse, even when the fundamentals improve. Traders have gotten used to selling Canadian dollars and it will take quite a sizeable jolt in the other direction, before this selling mentality shifts.

2) Growth. The Canadian economy slowed considerably in the second half of 2006 and in fact it was the worst performing of all leading nations in quarter 4, recording an annual GDP rate of just 1.4%. Although growth has picked up significantly at the start of 2007, it is difficult to shift the negative market sentiment towards the currency, caused by the poor economic performance in the last two reported quarters.

3) Interest rates. Canadian interest rates have been on hold since last summer, at a time when interest rates have been on the increase in Europe and even in Japan. The Canadian dollar has become a less attractive currency to hold because of the widening in interest rate differentials between the loonie and other currencies like the euro and the pound.

4) Big brother / little brother pushover syndrome. Current concerns over a slowdown in the US economy are having a greater impact on the Canadian dollar than on the US dollar. If data is negative for the dollar, it is more negative for the loonie. Canada is one of the world’s most important providers of commodities, from oil to base metals and to precious metals. It is an export dependent nation. The Canadian economy is inextricably linked with that of the US - the US provides Canada with the bulk of its export market. If demand in the US falters, so do Canadian exports and consequently the Canadian economy. Traders have been finding it relatively easy to kick the Canadian dollar, when the US economy misbehaves.

5) Speculative positioning. There has been a very strong wave of short positioning against the Canadian dollar in recent months and even with a major revival in the economy’s fundamentals, traders have continued to stack short positions against the currency. The latest commitment of traders report from the Chicago Mercantile Exchange reveals that there are currently more short positions held against the Canadian Dollar than for any other of the major currencies. This is a startling statistic and given the shift in fundamentals of late, any one event could trigger a massive unwinding of these shorts which could see a very sharp appreciation in the Canadian dollar in the not too distant future. Despite several attempts in recent weeks by the loonie, its progress each time has been halted and reversed, not by a change in fundamentals, but by determined and successful efforts by unknown sources to keep the currency down.

6) Risk aversion. The Canadian dollar appears to have come off worse than nearly every other currency during the 2 financial market bubbles we have experienced in the past few weeks. First there was the unwinding carry trade, which saw the loonie lose over 2 cents to the US dollar in a few days. It is difficult to understand just why the loonie was targeted, given the fact that the volume of carry trades involving the loonie must have been small. Its interest rate – at 4.25%, is not amongst the most attractive on offer for carry traders and given the loonie has been on sharp downward trend since last summer, loonie longs must have been few and far between and all carry traders should have been long since sold out of the currency. This week’s scare about US sub-prime mortgages is more understandable in terms of its impact as it raises wider questions about the soundness of the US economy and by association the outlook for Canadian exports and the loonie. However, as to why the loonie should plunge more than the dollar is something of a mystery, but that is probably another example of the little brother pushover syndrome, which is shaping market sentiment right now.

Will the loonie ever come back with more than a whimper? Yes! Improving fundamentals demand a stronger currency and markets cannot ignore facts for too long. The timing of a real loonie revival may depend on US fundamentals as much as on Canadian ones. A stronger dollar would no doubt see an even stronger loonie, but given the current positioning against the Canadian currency, a single event could trigger a long overdue appreciation and genuine trend reversal. As to what that event may be, we just don’t know, but we sure don’t want to miss the bus.