The Bank of England and the European Central Bank are both expected to keep financial policy on hold Thursday. What ECB President Mario Draghi says about low inflation could indicate whether the bank expands stimulus at future meetings and move the euro.
The BOE will release its decision at 7 a.m. Eastern. The central bank doesn’t normally release a statement when there is no alteration in policy, but central-bank watchers say that the BOE could be compelled to do so in light of the fast declining unemployment rate and what it means for U.K. interest rates.
The bank in August declared that it wouldn’t consider increasing its bank rate from 0.5% at least until the unemployment rate has fallen to 7% . That road map for the future of its financial policy is also known as forward guidance.
Recent data showed the U.K.unemployment rate sagged down to 7.4% in the three months to October, adding to speculation that the central bank could bolster rates sooner than it had expected and boosting the British pound.
That leaves the British central bank with a few options after its decision. It could keep with tradition and not release a statement, in which case there would be little market reaction, said Adam Cole, global head of foreign-exchange strategy at RBC Capital Markets in London.
Alternatively, the bank could release a statement that acknowledges the drop in the unemployment rate but downplays the risk of an immediate rate hike.
“We still think it would want to suggest that interest rate rises were likely some way off yet, reiterating for example that even if the unemployment rate did hit 7% by spring, a rate rise would by no means automatically follow,” said Nick Bate, a U.K. economist at Bank of America Merrill Lynch, in a research note.
Another possibility is that the statement hints that the unemployment threshold could be lowered, said RBC Capital’s Cole. “The danger is that it just devalues the forward guidance, to start changing the parameters only months after they introduced forward guidance in the first place,” he said.
The reaction in the British pound to such a potential change in forward guidance would be a decline in the sterling, with the euro rising to the mid-84 level against the pound, he added. One euro recently bought 0.8246 pound.
BMO Capital Markets also expects the central bank to keep policy “completely on hold” on Thursday, and expects the pound to trade in a range of $1.6375 to $1.6510 for most of the week. The pound has gained 1.9% against the dollar in the last three months, according to FactSet data.
In Frankfurt, the ECB is expected to release its decision at 7:45 a.m. Eastern.
While there isn’t any real expectation of a change in policy, investors will be parsing the statement as well as ECB President Mario Draghi’s subsequent press conference for clues about inflation concerns or further easing down the road. Draghi indicated in December that the central bank doesn’t have immediate plans to ease further.
Concern about inflation from Draghi could result in temporary euro losses but will likely have a limited impact, said Kathleen Brooks, research director at Forex.com, in a note. If Draghi appears worried and hints at further action, the euro could decline sharply, she added.
The ECB unexpectedly cut its benchmark rate to 0.25%, a record low, at its November meeting. The euro fell against the dollar in the wake of the rate cut, but gained more than 4% in 2013. In January so far, the euro is down 1.2% against the dollar.
“Inflation expectations have continued its downward trend since the latest refi rate cut in November and as this is the main concern for the ECB, we expect Mario Draghi to be dovish and signal that he is ready to act to ensure inflation expectations remain well anchored,” said Danske Bank economists and analysts led by Frank Øland Hansen in a note.
Preliminary data released Tuesday showed euro-zone consumer prices rose just 0.8% in the year ended December, down from an annual rate of inflation of 0.9% in November. Excluding more-volatile prices for food and energy, inflation came in at 0.7% in the year ended December. The central bank aims for an inflation rate of just below 2% in the medium term.
But Bank of America Merrill Lynch emphasized that the ECB won’t preemptively act on fears of deflation. “It would take a rapid pace of further FX appreciation, a severe global downturn, or significant change in wage setting behavior for euro area inflation expectations to fall sharply (rather than deteriorate slowly) and/or fall rapidly into deflation,” wrote economists and strategists led by Laurence Boone.
The ECB has said it has a number of policy options available if it needs to ease further, including asset purchases and a negative deposit rate. As such, the market reaction to a mention of the available options is likely to be limited, said RBC Capital’s Cole.
A reference to the strength of the euro, which Draghi made explicitly in February, could send the euro tumbling, he added. “If [the ECB] did talk about the disinflationary impact of a strong currency, the knee-jerk reaction would be to sell euros,” he said.
