Frantic Friday: China Cuts Interest Rates, Draghi Lays Euro Low

Currency markets are hopping on Friday following two earth-shattering developments courtesy of European Central Bank (ECB) chief Mario Draghi and the People’s Bank of China (PBoC).

The EUR (€1.2438) took a sharp turn lower after Draghi’s speech regarding inflation at the Euro Banking Congress in Frankfurt earlier today. The ECB chief again indicated that the eurozone’s policymakers will do what they must to raise inflation back to the desired target. His assessment of growth and inflation is supporting market expectations that the ECB will need to adopt full-blown quantitative easing sooner rather than later.

Meanwhile, China unexpectedly cut its benchmark interest rates for the first time in more than two years this morning to lower borrowing costs and lift a cooling economy that is on track for its slackest annual growth in over two decades. The PBoC will slash one-year benchmark lending rates by 40 basis points to +5.6%, and one-year benchmark deposit rates would be lowered by 25 basis points, it said, adding that the reductions would be effective on November 22.

The PBoC also looked to liberalize deposit rates to allow Chinese banks to pay 1.2 times the benchmark level, a modest but significant increase from 1.1 times previously. The initial market reaction has given commodity-sensitive currencies a real boost, especially AUD ($0.8705), NZD ($0.7923), and CAD ($1.1282).

EUR Plummets on Inflation Expectations

The euro bear got a subtle hint yesterday to consider “not” booking any EUR profits just yet, all because the EUR bull happened to be blinded by flash purchasing mangers’ index (PMI) numbers. The ones that did nothing should be thanking Draghi this morning, as he managed to “put the boot in” with another whatever-it-takes kind of moment.

His assessment of the eurozone in his speech would strongly suggest that the ECB is about to up the ante as early as the December meet in a few weeks. His dovish comments — inflation is more challenging, committing to recalibrating size, pace, and composition of asset purchases, and the potential broadening of channels through which the ECB intervenes — are currently suffocating the EUR outright and on the crosses (fresh day lows for EUR/JPY €146.46, EUR/GBP €0.7938).

Not surprisingly, EUR/CHF has managed to climb to a one-week high (€1.2032) on thoughts of lower ECB funding. European/U.S. rate divergence is lending the Swiss National Bank (SNB) a helping hand ahead of the Swiss gold referendum on November 30. With the U.S. dollar having a strong run this morning driven by “what if” scenarios, it managed to push USD/CHF higher ($0.9670), and it allowed EUR/CHF to be supported to gradually move away from the SNB’s well publicized “floor.”

Draghi needs to get a real “bang for his buck” before hot air whistles away and the ECB loses street credibility. Eurozone policymakers will need to make sure that they have exhausted all existing balance sheet avenues before they begin to charge down the route of no return: sovereign bond purchases. To date, the ECB has had the minimum of success in expanding its balance sheet. In fact, it has actually declined -€11B since the beginning of September. The EUR will remain very sensitive to short interest rate trends, with further downside very much on the cards.

PBoC Wields an Axe

As for the world’s No. 2 economy, serious concerns abound globally over the real possibility that China will miss its annual growth target (set at 7.5% for 2014) for the first time in more than a decade.

Previous efforts to boost economic growth have fallen flat, likely prompting the PBoC to make its surprise move on Friday. But is it enough? And will it be the only move the bank will make? It’s common knowledge Chinese economic virility is essential to propping up the world’s fortunes.

It’s conceivable Beijing may yet take more drastic measures by injecting liquidity into its banking system before year’s end.

All’s Quiet on the FX Front Next Week

If you thought the FX market was slow this week, next week will be a challenging one for most, as both FX ranges and market volumes are expected to take a big step back due to various bank holidays.

Japan will not be kicking things off in the Asian session as they celebrate their Labor Day on November 23. Bank of Japan (BoJ) Governor Haruhiko Kuroda will grab most of the attention from his planned speeches on Monday. He is scheduled to speak at a meeting with business leaders in Nagoya and at the Paris Europlace International Financial Forum in Tokyo. The governor is not expected to stray too far from the BoJ’s official rhetoric from last week’s monetary policy meet. Meanwhile, a German Ifo business confidence survey due on November 24 should be capable of keeping the EUR moving.

The market will try and engage with the minimum of interest in U.S. preliminary gross domestic product (GDP) figures on November 25, and U.K. quarter-over-quarter GDP data on November 26. No one wants to have too much strapped on as the U.S. begins to celebrate Thanksgiving, the largest and most traveled holiday period in the American calendar. Historically, FX volumes plummet over the two-day festivities (it’s a financial half day, but most make it a long weekend). Be aware that the Organization of Petroleum Exporting Countries happens to have an all-day meeting scheduled for the same day — could the ministers surprise the crude oil market?

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Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell