Battle of the Central Banks: ECB, BoJ, BoC and a Surprise BoE

Despite the Bank of Japan (BoJ) Governor Haruhiko Kuroda, the Bank of Canada (BoC) Governor Stephen Poloz, and the Bank of England’s (BoE) Monetary Policy Committee (MPC) votes taking the lead in in the first half of this week, capital markets are firmly focused on the European Central Bank (ECB). Tomorrow’s ECB policy-setting meeting is when President Mario Draghi could introduce the quantitative easing (QE) program most market watchers expect.

The market has been pricing in an ECB sovereign-buying outcome. The consensus is for European interest rates to remain unchanged, while the ECB extends its program of asset purchases to include sovereign as well as corporate bonds. What percentage mix, how many, and from where has yet to be divulged. The issue is how the program is designed and whether it is seen as credible and sufficient? Nevertheless, investors cannot take anything for granted. Last week’s surprise Swiss National Bank decision to do away with the franc cap proves complacency is not a wise investor strategy when it comes to central bank rate decisions and policymakers’ statements.

What to Expect from the ECB?

The program is not expected to be open-ended QE. Expect to see Draghi use the post-meeting press conference to talk about the size of the program and whether it’s fixed — he will be required to talk up an open-ended solution. The market expects the EUR to see large swings in the weeks ahead. The point of interest of the ECB’s meeting is not only the initial size of the stimulus program but also the explicit balance sheet target. Market participants are now using the early 2012 levels, €2.6 trillion to €3.1 trillion, as a reference. If the target is the upper end, the EUR/USD (€1.1575) may plunge to fresh lows. If the ECB disappoints, it could trigger a massive short covering rally as the market is tilted to the short side. The first line of strong resistance is expected near €1.1745.

No matter what, everyone should be expecting plenty of market volatility, with the risk that the market will “buy the rumor, sell the fact.”

BoE Members Come in from the Cold

The BoE policy committee’s meeting minutes released this morning reveals members Martin Weale and Ian McCafferty have backed down on calling for the bank to raise interest rates. All nine MPC members voted to keep rates unchanged. From their perspective, the belief is a rate rise would prolong the U.K.’s low inflation problem. It was only six months ago that the pair jointly voted to tighten monetary policy. Collectively, all MPC members are alert to the risk that low inflation might become entrenched, and they see the possibility of an annual fall in U.K. prices in the first half of 2015. It seems that the BoE considers medium-term inflation risks may have shifted.

The surprise vote encouraged volatile sterling price action. The GBP/USD managed to print session lows below the psychological £1.5100 handle after the BoE dissenters changed their tune. So far, the pound has been unable to hit fresh 17-month lows despite the dovish actions. Perhaps GBP requires help stateside to take on its lows?

No BoJ Surprises

The BoJ stuck to its monetary policy script overnight, but cut its core consumer inflation projections issued only a few months ago. Again, plummeting crude oil prices are to blame.

As expected, the BoJ pledged to increase the monetary base at an annual pace of ¥80 trillion ($676 billion) through purchases of government bonds and risky assets. It also extended the March deadline of two loan programs by one year that is aimed at lending rather than hoarding cash. It increased the size of one of the programs by ¥3 trillion to ¥10 trillion.

Kuroda went to great pains to reiterate that Japan’s positive economic (virtuous) cycle remains intact, with no changes in the underlying trend in the consumer-price index (CPI). Japanese policymakers are expected to remain proactive and assess risks and adjust policy as needed. Kuroda repeated that CPI is likely to reach the +2% target in mid-2016 (some members were cautious about the timeframe). Falling oil prices should support global growth but will limit CPI gains in the short term. Policymakers are not considering cutting interest rates paid to excess reserves parked at the BoJ.

The yen (¥117.74) strengthened outright as the BoJ kept asset purchases steady. Expect investors to curtail their trading ahead of the ECB’s announcement on Thursday. Hopes of ECB action have been dampened this morning by ECB Governing Council member Ewald Nowotny who said the market shouldn’t focus exclusively on the meeting’s outcome. “One should not get overexcited about it,” he said. He reiterated that he did not expect deflation in the eurozone and that it was harder to fight deflation than inflation.

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