ECB BoE Expected to Cut Lending Rates

As the grim economic news continues to lead the local newscasts, the European Central Bank and Bank of England are both expected to announce interest rate cuts tomorrow. In the past two weeks we have seen rate cuts from several of the “big seven” currencies with Australia finally getting in on the act on Monday when the Reserve Bank of Australia (RBA) cut seventy-five basis points from the Cash Target Rate lowering it to 5.25 percent.

Last week, the US Federal Reserve continued its pattern of rate cuts by shaving fifty points from the benchmark rate, while the Bank of Canada managed a more modest twenty-five basis points, reducing lending rates for the two countries to 1 percent and 2.25 percent respectively. The Bank of Japan meanwhile, made the largest rate cut – at least on a percentage basis – when it lowered the nation’s main lending rate to 0.3 percent from 0.5 percent.

Fifty Basis Point Cut Expected by ECB

The European Central Bank is currently meeting in Frankfurt and all indications are that the ECB will reduce its key lending rate by fifty basis points to 3.25 percent. If the rate is delivered, it will come on the heels of a fifty-point reduction on October 8th which marked the region’s first rate cut in five years.

European Central Bank President Jean-Claude Trichet has long clung to a policy aimed at curbing inflation, and it was while citing inflation as a greater threat than a recession, that Trichet announced a rate hike just last July. At a time when most of the EU’s trading partners were acting upon – or at least considering rate cuts to boost production – the ECB was busy raising interest rates by twenty-five basis points.

But how things can change after a few months. While inflation is still above the ECB’s target of two percent, it is obvious to everyone that the euro-zone countries will suffer further setbacks in the next few months that will jeopardize this growth target. The outlook is so negative that some analysts are predicting that the ECB will make another rate reduction in December.

Possible Full Percent Cut for the UK?

While most economists agree that in order to jumpstart the economy the UK must be aggressive in it’s cuts, you won’t find a majority betting the farm on a reduction of a full percent. Fifty to seventy-five points seems to be the most likely scenario as the Monetary Policy Committee (MPC) has never exceeded fifty basis points when reducing rates.

Having said this, perhaps the time is right for the MPC to make a little history of its own right now. There is ample evidence that England’s economy is slowing and may actually now meet the technical definition of a recession (two quarters of negative growth).

If it is not technically a recession, from an emotional standpoint, it may as well be as for the average person, I’m sure it makes little difference what title you want to use to describe the current state of affairs. The housing bubble continues to wreak havoc on homeowners with one in five now carrying negative equity on their homes; Gross Domestic Product has contracted in each of the past three months; and employment concerns are still front and center. All this translates into the lowest level of consumer confidence in years.

What Does this Mean for Forex Traders?

The typical reaction when interest rates are reduced is for money to flow away from the currency of the country making the cuts. This is because yields fluctuate in relation to interest rates, and the lower the interest rate, the lower the yield earned when holding the currency.

Some might argue however, that we are not living in typical times just now, but given the expected rate cuts, weak economic news from both regions, and growing demand for the US dollar, analysts remain bullish on the dollar over most other currencies.

And don’t discount the “Obama Factor” – for now at least, there is a growing sense of optimism in the US; whether this can buoy markets through renewed investor and consumer confidence remains to be seen.

About the Author

Scott Boyd has been working in and writing about the financial industry since the early 1990s. As a technical writer and project manager with several of Canada’s leading financial institutions, Scott has produced educational materials for investment system end-users including portfolio managers and traders. Scott now administers and contributes to OANDA FXPedia and regularly provides commentaries for the OANDA FXTrade website.

This article is for general information purposes only. It is not investment advice or a solicitation to buy or sell securities. Opinions are the author’s — not necessarily OANDA’s, its officers or directors. OANDA’s Terms of Use apply.