G7 central banks set to band together in coronavirus fight

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3 March 2020

thomasdodds

Trading in the FX market remains dominated by coronavirus concerns.

A
s the number of confirmed cases outside of China continues to rise at an accelerated rate, investors’ attention has turned to what kind of response markets can expect from central banks around the world. In an extraordinary move, central bankers among the G7 countries will be holding a rare conference call at 1pm UK time (14:00 CET) today in what appears to be a coordinated effort to tackle the potential negative economic repercussions triggered by the virus. A statement will follow soon after, which we expect will indicate a broad consensus among policymakers that aggressive rate cuts will be required in order to fight off the downside risk.

As the market thought they might, the Reserve Bank of Australia’s slashed interest rates overnight by 25 basis points to 0.5%, with Governor Lowe citing coronavirus concerns, while keeping the door ajar to additional cuts. He also stated that he expected other major banks to follow suit, with the onus now squarely on the Federal Reserve. Fed fund futures are now pricing in a cut in the US as a certainty, with the real question likely to be whether or not this will be a standard 25 basis point rate reduction, or something more substantial.

Next up will the Bank of Canada’s policy meeting on Wednesday. We now think that there is a very good chance they will follow suit with the RBA, with a 25 bp rate reduction heavily priced in.

Euro continues to rally on ECB’s limited room to cut

As for the euro, the common currency continued to climb higher on Monday and is now trading back above the 1.11 mark versus the dollar.

The move higher witnessed in the euro versus the dollar in the past ten days or so goes back to the rationale that we’ve had for such a move in the past few months – that there’s simply more room for policymakers at the Federal Reserve to cut interest rates than there is at the ECB. Futures pricing suggests that markets believe as many as four rate cuts from the Fed could be on the card this year in a bid to combat the downside risk posed by the virus. With rates in the Euro Area already in negative territory, the ECB doesn’t have such a luxury – we think that 10 basis points of cuts from the Governing Council is just about the limit as to how much lower rates can go there.

The ECB will be meeting next week (12th March). This promises to be one of the bigger event risks in the FX market in the next couple of weeks.

Brexit negotiations set to begin in Brussels

Away from virus fears, the pound was under pressure again, remaining pinned below the 1.28 mark versus the dollar this morning. This is partly due to investors fleeing higher risk assets and partly to uncertainty surrounding Brexit.

Approximately 100 UK officials are heading to Brussels this week as the first round of talks with the European Commission begin in earnest. Boris Johnson continues to take a hard-line stance, stating that the UK will not be bound by EU rules or the jurisdiction of its top court. Growing investor bets in favour of BoE rate cuts has also far from helped the pound. Investors are now pricing in around an 80% chance of a 25 basis point cut when the bank next meets on 26th March. We see a very good chance of this being the case, although the fact that almost every other major central bank will do the same, should limit the cuts downside impact on the pound.