NEW TERRITORY FOR BOE MEANS POSSIBLE NEW HORIZONS FOR POUND

NEW TERRITORY FOR BOE MEANS POSSIBLE NEW HORIZONS FOR POUND

The Bank of England announced yesterday that it would be utilizing its first raft of Quantitative easing measures, essentially creating money and using the funds to stimulate economic growth by purchasing government and corporate bonds. The UK also saw its benchmark interest rate cut to its lowest-ever level of 0.5 % from 1% with the European Central Bank also cutting by half a point to 1.5%.

BoE policy-makers are hoping that buying government securities, which will be done to a total of 75 Billion Pounds-worth over the next three months will encourage more liquidity in the economic system as a whole as money supply increases and prices expand from the top-down. The move reflects a conviction that the standard policy tool of short term interest rates has become increasingly ineffective. Purchases will be focused on corporate credit markets, so as to improve lending to the private sector, and medium- and long-term government bonds. The BoE said it would "monitor the effectiveness of this purchase program in boosting the supply of money and credit and in due course raising the rate of growth of nominal spending, adjusting the speed and scale of purchases as appropriate. With the latest 0.5% reduction, the BoE rate is rapidly approaching that of the US Federal Reserve, which has set its benchmark at a range from 0 to 0.25%.
In Europe, the ECB's reluctance to bring down interest rates more quickly has attracted widespread criticism from economists, who argue that the economy of the 16-nation euro zone is contracting so sharply that little would be lost by lowering borrowing costs faster. Senior officials on the ECB's rate-setting Governing Council are split over where to go next. Athanasios Orphanides, the central bank governor of Cyprus and a former economist at the Federal Reserve, has emerged as a spokesman for considering pushing short-term rates down fast and considering new policy tools. The German members of the council, Jürgen Stark and Axel Weber, have been more skeptical and have tended to worry that ultralow interest rates helped cause the current crisis in the first place. On Thursday, the European Union's statistics office confirmed its earlier estimate that quarter-on-quarter GDP in the euro zone shrank 1.5% during the October to December quarter, after a 0.2% drop in the previous quarter.

The FX market reaction to the above events was fairly muted, with most fun being had on equity markets with main indices across the world dipping sharply in response to a general despondency over the potential efficacy of the Central Bank measures. The reduction in both European and UK interest rates was widely anticipated by speculators and interest rate futures which resulted in very little overall movement with GBP/USD continuing to hang on to the 1.41-1.42 mark and GBP/EUR looking sheepish around 1.12.

Data out today is mainly US based with Non-Farm Unemployment and the US unemployment rate both out at 2:30 GMT, both of these are expected to be negative and may therefore prompt some dollar weakness in the run upto the afternoon. This may however fade into Dollar strength though as Dollar-denominated market positions are pared for the weekend and as the potential horror of the US data sinks in prompting some heavy risk aversion trades. Expect GBP/USD to continue in its channel of 1.41-1.43 for the day with GBP/EUR possibly testing 1.1150.

Raphaels Bank CFX Team
0800 587 8722
cfx@raphael.co.uk
www.raphaelsbank.com/cfx

This newsletter is the personal view of Raphaels Bank and nothing herein should be construed as a recommendation or advice. The Bank accepts no responsibility for the correctness or otherwise of any matters contained herein.

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