SCOREBOARD: Rates mania

The ECB disappointed some by leaving rates steady at 1.5 per cent on the main refinancing operations, but they did nevertheless extend their liquidity operations as expected. The bank already reintroduced three-month tenders a little while ago and now they've said they will conduct two longer-term refinancing operations, one with 12 months' maturity (this month) and one with 13 months' (in December). The ECB also decided to launch a new covered bond-buying program.
 
On the rates front there wasn't really any guidance as such. Indeed, while the ECB reiterated that the Governing Council continues to view the risks to the medium-term outlook for price developments as "broadly balanced”, they noted that on growth, the risk is – in an environment of very high uncertainty – to the downside. The problem of course is that inflation is currently well above the band and has actually accelerated. On that basis, and assuming that the ECB has not dropped or will not overlook its mandate, then rates are unlikely to be cut in the near-term without a Greek default.
 
The Bank of England in contrast had no such hesitation. It's quite clear they've disregarded their inflation target – the target is 2 per cent and the current inflation rate is 4.5 per cent and no, it's not just because of VAT increases. Last night the MPC, with the blessing of the government, decided that they would print more money. An additional ₤75 billion is to be printed and recall that in their assets program, the bank predominantly buys gilts and "smaller quantities of high-quality private sector assets”. Well may you ask what need the bank has to buy gilts.
 
Monetary policy is already extremely stimulatory, the UK does not face depression nor deflation (the original excuse for QE) and they are not even in a recession. Recent indicators have turned up. Further, the 10-year rate has already fallen by 154bps since a peak this year (80bps since July) and sits pretty much at record lows. The additional danger stems from the fact that the bank, by caving into this pressure, is simply accentuating the markets' addiction to free or excessively cheap money. This is creating, and will continue to create, distortions in the market and will make it much more difficult when the UK does indeed decide to normalise policy. They are adding to rather than solving problems.
 
For what it's worth, the bank's line is that the heightened downside risks to the outlook (from euro area sovereigns and banks) warrant further action right now. "The deterioration in the outlook has made it more likely that inflation will undershoot the 2 per cent target in the medium term. In the light of that shift in the balance of risks, and in order to keep inflation on track to meet the target over the medium term, the Committee judged that it was necessary to inject further monetary stimulus into the economy.”  
 
Following stronger rhetoric from the Europeans about recapitalising banks etc, these central bank actions have certainly aided the risk bid. European equities surged again with the Dax up 3.2 per cent, the CAC up 3.4 per cent and the FTSE up 3.7 per cent. Industrials, financials and basic materials seem to be the key beneficiaries of recent policy measures with French and UK financials up 7 per cent while in Germany financials were up 4 per cent.
 
Across the sea, Wall Street had a good session, although not quite up their with their cousins in Europe. This is despite the fact that economic data was again better than expected. Jobless claims rose modestly to 401,000 in the week to October 1 from 395,000. The good news here, obviously, is that this result confirms the recent downtrend we've seen. It seems then that the labour market is actually improving. At the close though the S&P500 was 1.8 per cent higher (1164) with financial, industrials and consumer services the key outperformers. The Dow then rose 182 points (11122), the Nasdaq was 1.9 per cent higher (2506) and the SPI rose 1.5 per cent (4127).  
 
In the forex space the US dollar was offered and so the Australian dollar got a solid bid, rising 124pps to sit at 0.9758. Similar moves were seen in the euro, which rose 117 pips to 1.3446, while pound sterling was up only 27 pips to 1.5456 – which is a good outcome considering the BoE is printing more money – while yen was little changed at 76.62. The weaker US dollar and positive sentiment more generally saw another solid leg up for commodities. Crude was 3.7 per cent higher on WTI ($82.61) and 2.9 per cent higher on Brent ($105.7). Gold rose a few bucks to $1650, silver was 5.6 per cent higher and copper rose 4.6 per cent.
 
Finally for debt, US treasuries sold off the yield – the 10-year rose 12bps to 2 per cent, the 5-year rose 7bps (1.01 per cent) and the 2-year was a bit over 1bps higher (0.27 per cent). Aussie futures shed 9 ticks on the 3s (96.42) and 11 ticks on the 10s (95.73).
 
Bits and pieces otherwise. In Germany, factory orders fell 1.4 per cent in August after a 2.6 per cent fall in July. UK house prices fell 0.5 per cent in September and are 2.3 per cent lower annually, according to Halifax. Still in the UK, the index of services rose 0.9 per cent in the three months to July. Then in the US, the ICSC report that retail sales surged 5.5 per cent year-on-year in September.
 
Nothing for Australia today and tonight the big one is US payrolls. The market looks for a 55,000 increase in payrolls while the unemployment rate is expected to stay at 9.1 per cent. Other than that, it's worth looking out for German industrial production and UK producer prices.

Adam Carr is senior economist at ICAP Australia. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles.

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