Dolan: The BOE Surprises, The ECB Bores, And NFP Looms


The British pound took a tumble this morning after the Bank of England (BOE) defied market expectationsand expanded its asset purchase plan (aka quantitative easing, or QE) by an additional GBP 50 bln to a maximum of GBP 175 bln.

With generally improving economic data in recent months, the expectation was that the BOE would either stop at the 125 bio pounds of QE already done or at least pause before deciding whether to finish out the GBP 150 bln allotment.

That they went ahead with a GBP 50 bln increase unnerved traders, who took it as a sign that the BOE foresees more entrenched deflationary pressures and a weaker outlook than previously thought.

Quantitative easing is frequently viewed as short-hand for printing money and is typically seen as a negative for the currency of any country pursuing it.

That was certainly the case today as the pound has fallen by about 1.2% against the USD and about 1.0% against the euro since the BOE announcement at 0700EDT. An additional GBP 50 bio of government borrowing (about $85 bln) may not seem like much to us in the U.S., but it's a significant amount relative to the size of the U.K. economy. The additional BOE balance sheet expansion will increase already heightened concerns about U.K. debt levels and fiscal stability, which should add to pressure on the pound. About the only GBP-positive element is that the BOE said it would expand its purchases of long term bonds, drawing in international demand for gilts, and with it demand for pounds to pay for them.

Where the BOE surprised, the ECB plodded along, holding rates steady at 1.0% and declining to undertake any enhanced credit support initiatives.

Market speculation had been that the ECB might announce some form of direct lending to European firms, such as buying commercial paper, to offset still-restrained bank lending.

Instead, ECB President Trichet downplayed lending concerns, saying that lower credit demand was the culprit, not supply.

The ECB generally maintained the view that deflation will be temporary, and that, while European labor markets may deteriorate more substantially in the near term, it still foresaw a modest 2010 recovery. On interest rates, the ECB is on hold well into 2010, as Trichet indicated there was no discussion of lowering benchmark rates at today’s meeting. On recent strength in the euro, Trichet reverted to noting the U.S. pledge to support a strong dollar, and said that's the ECB 'vision' too. I can't shake the impression that he's increasingly bothered by EUR strength, but that it's not extreme enough to step up to verbal intervention.

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Central bank decisions aside, the current market environment remains driven by risk sentiment, which brings us to tomorrow's July U.S. NFP report. The optimism is palpable that we'll see a more meaningful decline in jobs being shed, so the risks seem tilted to disappointment, which may come from an above consensus rise in the unemployment rate judging by the new cycle low in the Conference Board's labor differential.

As Harry Tuttle, Robert DeNiro's character in the move "Brazil," liked to say, "Remember, we're all in this together," I think risk assets will continue to respond as a whole. The key will be whether risky assets (stocks, commodities, carry trades (long cross-JPY)) can extend and sustain recent gains on a more favorable NFP decline (e.g. better than -300K); if they can't, then a risk retreat seems likely.

Brian Dolan, is Chief Currency Strategist at