Euro Pound Tumble Ahead of Rate Decisions – Global ZIPR In Store?

Euro Pound Tumble Ahead of Rate Decisions – Global ZIPR In Store?

It is central bank night in FX as both the BoE and the ECB are expected to lower rates significantly later in the day.Ahead of the announcements by the two major central banks, the surprise -175bp rate cut by Sweden’s Riksbank sent risk currencies into a tailspin in early European trade as traders anticipated the possibility of even steeper rate cuts than already forecast. The market projects a -100bp rate cut for BoE and -75bp rate cut for ECB, but given Risksbank’s staggeringly large move, UK and European officials may opt for an even more dramatic policy gesture.

Certainly the economic background provides a strong argument for a more aggressive move as the data yesterday in all the G-4 countries indicated a near collapse of economic demand.Services PMI in UK and Europe and ISM Non-Manufacturing in US all hit record lows suggesting that economic activity has slowed to a crawl as the deflationary impact of the credit crisis spreads its way across the globe.

Many analysts now believe that G-4 rates may all ultimately converge at near zero levels as monetary authorities desperately try to reflate the system. Furthermore central bankers and fiscal officials may have to resort to highly unusual and unmarket-like behavior to prop up demand.Yesterday’s proposal by US Treasury to actively lower mortgage rates in order to stimulate borrowing may be the first of many efforts to galvanize demand more directly.Cleary capitalizing banks as a means of restoring credit facilities has failed miserably with banks preferring to hoard their capital investing it only into the long end of the curve of government bonds.The transmission mechanism of monetary policy is not working and is unlikely to work even if rates approach ZIRP as risk assumption has ceased to exist in the marketplace.

With euro and cable having sold off significantly in the European session, we doubt that they may see further declines in North America. For the time being 1.2500 in EUR/USD and 1.4500 in GBP/USD remains firm support and the units may even bounce s bit if the two central banks cut by more than expected in a classic sell the rumor buy the fact dynamic. Nevertheless, the longer term implications of lower rates continue to weigh on the two currencies. As their interest rate premium to the dollar disappears so will their tendency to trade on risk assumption/risk aversion flows. For the time being the greenback remains the king of the jungle for lack of any better alternative.

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