The Euro (EUR) holds minor gains against the British Pound (GBP) for the third consecutive day on Monday, favoured by European Central Bank (ECB) – Bank of England (BoE) monetary policy divergence. Euro bulls, however, are struggling to find acceptance above 0.8550, with market volatility relatively low in a calm summer trading session.
The Euro is drawing some support from investors’ growing confidence that the ECB is poised to hike interest rates after its September meeting.
Eurozone Gross Domestic Product (GDP) and Employment Change data seen last week endorsed this view. Economic growth bounced back in the second quarter after stagnating in the previous quarter, and employment grew, albeit at a moderate pace, allowing the ECB to hike interest rates by a quarter point in September to tame high inflationary pressures.
BoE dovishness, UK fiscal uncertainty keeps Pound’s tone cautious
The case for the BoE, however, is less clear, with recent monetary policy decisions showing a split committee, while Governor Andrew Bailey’s rhetoric leans towards the dovish side. UK GDP grew in Q2, but July’s Industrial Production data hinted at an economic slowdown in the third quarter of the year, which, together with benign consumer inflation data in June, strengthens the case for a hold at next month’s monetary policy meeting.
The political scenario is not encouraging for Pound bulls either. Rabobank analysts warn that “uncertainty about the budget could keep the UK market nervous into the autumn.”
Rabobank notes that while “the market may be more forgiving if the government is borrowing to invest, … extra gilt supply will still have to be absorbed, and infrastructure projects are likely to take years before they raise capacity.” The bank also stresses that, “either way, Burnham’s plans to ease the cost of living for the electorate still must be paid for,” underscoring the lingering concerns around how the UK’s looser fiscal stance will ultimately be financed.
Central banks FAQs
Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.
A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.
A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.
Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.
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