ECONOMETER

There has been a veritable feast of central bank activity and decisions with most attention having been on the Fed’s decision.  In the event the FOMC meeting delivered no surprises in its decision and statement.  Basically the Fed acknowledged the recent improvement in economic activity but continued to see inflation as subdued and maintained that policy rates will remain low for an “extended period”.  The Fed also noted that most liquidity facilities were on track to expire on 1 February suggesting that they remain on track to withdraw liquidity.  

There was similarly no surprise in the Riksbank’s decision in Sweden to leave interest rates unchanged, with the Bank reiterating that it would maintain this stance through the autumn of 2010.  The SEK has been stung by outflows due to annual payments of premiums to mutual funds by the Pension Authority but the impact of this has now largely ended leaving the currency in better position.  Norway’s Norges Bank unexpectedly raised interest rates, for a second time, increasing its deposit rate by 25bps to 1.75%, with the surprise evident in the rally in NOK following the decision.   The other central bank to surprise but in the opposite direction was the Czech central bank which cut interest rates by 25bps.  

In contrast to the Norges Bank’s hawkish surprise the RBA has helped to toned down expectations for further rate hikes in Australia, with Deputy Governor Battellino suggesting that monetary policy was back in a “normal range” in contrast to the perception that policy was still very accommodative.   Weaker than expected Q3 GDP (0.2% QoQ versus forecasts of a 0.4% QoQ rise) data fed into the dovish tone of interest rate markets fuelling a further scaling back of rate hike expectations, casting doubt on a move at the February 2010 RBA meeting and pushing the AUD lower in the process.  Against this background AUD continues to look vulnerable in the short term, especially under the weight of year end profit taking and the resurgent USD.  

There was also some surprise in the amount of lending by the ECB, with the Bank lending EUR 96.9 bn in third and final tender of 1-year cash despite the cost of the loan being indexed to the refi rate over the term of the loan rather than being fixed at 1%.  There was also a sharp decline in the number of banks bidding compared to earlier 1-year auctions but at a much higher average bid.  This implies that some banks in Europe remain highly dependent on ECB funding despite the improvement in market conditions.   The EUR continues to struggle and its precipitous drop has shown little sign of reversing, with the currency set for a soft end to the year.  A break below technical support around 1.4407 opens the door to a fall to around 1.4290.   

The USD is set to retain its firmer tone in the near term though we would caution at reading its recent rally as marking a broader shift in sentiment.  The move in large part can be attributed to position adjustment into year end and is being particularly felt by those currencies that have gained the most in recent months.  Hence, the softer tone to Asian currencies and commodity currencies which appear to be bearing the brunt of the rebound in the USD.   Going into next year USD pressure is set to resume but for now the USD is set to remain on top, with the USD index on track to break above 78.000.