There were a couple of new developments in the central bank world to spark big price action for currencies yesterday. Let's review the events and figure out what it means going forward.
Start the printing presses! Due to the increasingly gloomy economic outlook and intensifying pressure from the public, the BOE has decided to fire up its quantitative easing program again. As widely expected by the market, the central bank announced that it would chuck another 50 billion GBP into the British economy to bring its quantitative easing program to 375 billion GBP.
The decision, according to the BOE, was due to the "tight credit conditions and fiscal consolidation" and the "increased drag from the heightened tensions within the euro area." That's the BOE basically saying "Yo homies, the economy's gettin' very bad and there ain't 'nuff money going around. So here's a big wad of cash for ya'll to spend."
If you recall, the most recent GDP report showed that the country shrunk during the first quarter of this year, which essentially means that the U.K. has fallen into recession. A country is considered to be in a recession if it experiences two consecutive quarters of negative growth.
Moreover, various leading indicators from the U.K. have been less than stellar. The country's manufacturing PMI came in at 48.6, which is below the 50.0 level that divides growth from contraction. The construction PMI also mirrored this as it printed a reading of 48.2. Lastly, the services PMI released a few days ago came in much worse than expected at 51.3.
Whether the BOE's QE expansion works or not remains to be seen, but given the economic situation in the U.K., it's not like the BOE had any other choice.
The fact is, the British economy hasn't been performing well in the last two quarters and forward-looking economic indicators suggest that the next six months will be pretty much the same. It only makes sense for the BOE to do something.
For the first time in 7 months, the European Central Bank (ECB) has decided to reduce interest rates. The benchmark interest rate now stands at 0.75%, the lowest level since the ECB's inception.
ECB President Mario Draghi said that the "downside risks" the bank had been talking about in its previous statements has finally materialized, which has left the bank with no choice but to act. Draghi emphasized that economic growth has been very weak, which has increased uncertainty and has greatly reduced market confidence.
You might be thinking that the 0.25% cut was pretty significant, but in reality it actually doesn't do much for the banking sector. As a matter of fact, the bank has already lent more than 1 trillion EUR in its Longer-Term Refinancing Operations (LTRO), which means the 1.00% rate didn't really stop banks from taking out loans.
And here's a little known fact that the headlines don't tell you: the ECB also slashed the deposit rate all the way to zero. What this means is that the ECB will pay absolutely nothing on overnight deposits.
This move will hopefully force banks to lend their money to other banks instead, where they will receive a higher interest rate.
The BOE and the ECB may have chosen different paths, but their destination is one and the same. Both central banks simply want to bring their respective economies out of their slumps by stimulating growth.
With these policy changes, and given enough time, I believe that the pound and the euro could start reversing their losses, especially if the Fed follows suit and expands its own quantitative easing program.
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