China Cuts The Lending Rate, BOE To Remain On Hold

Lower Chinese rates should support the Aussie

We had a flash start to the week with China cutting its rates for the third time in 6 months. The one year lending rate has been lowered from 5.35% to 5.10% following the soft CPI read during the weekend. Further easing is on the agenda given that Premier Li Keqiang’s 7% growth target is in danger. PBoC’s determination to boost the economic growth and improve the credit conditions were good news for the Aussie. AUD/USD remained well bid above 100-dma (0.7860) despite pessimistic RBA forecasts last week. For a quick recap, we remind that the RBA lowered its growth forecast and predicted a higher unemployment in its May Statement of Monetary Policy. As the revisions are mostly due to slowdown in China and subdued commodity prices, there is nothing spectacular in the most recent RBA statement. This being said, following the latest RBA rate cut to 2%, an additional easing is certainly not on the wire for the time being. Given the dovish Fed expectations, the rate differential still plays in favour of AUD-denominated assets, the carry flows are expected to remain supportive of the Aussie.

No resolution expected on Greece today

Greece continues to make the headlines with its government desperately seeking recognition on its progress thus far ahead of its major debt repayment deadline to the IMF.
It is hoped that any progress will enable the ECB to restore liquidity to its ailing banks. With the general index down over 3% and the banks shedding an average 8% there is certainly a sense of urgency.

Given that Syriza’s promises to its electorate to ease up on austerity measures will likely not sit well at the euro group meetings today, a resolution is not expected.

BoE: no reason to rush into an early rate normalisation

The Bank of England meets today and will certainly maintain the status quo. The outright Conservative victory cooled-off tension on the BoE; the anticipation of a tighter fiscal policy from a Conservative-led government gives the BoE a good flexibility to maintain the bank rate at the historical low of 0.50% and keep the asset purchases target unchanged at 375 billion pound.

While the BoE meeting is expected to be a non-event, the quarterly Inflation Report (Wed) should provide more colour on BoE’s future policy guidance particularly since we now have greater visibility on the political situation. Following more than 50% drop in oil prices over the past ten months, the headline CPI remains at 0.0% y/y since February, while the core inflation eased to 1.0% in March for the first time since 2006. The recent rebound may well lead to greater stabilisation in oil markets but will take time to push the headline inflation toward BoE’s 2% target. In this macroeconomic and political context, the BoE will be tempted to keep its soft policy rhetoric. There is no need to rush into an early rate normalisation; the first rate action is not expected any time sooner than the first quarter of 2016.

The softer BoE expectations and rising fears of a “Brexit” weigh on the GBP-complex. Cable’s post-election rally remained capped at 1.5523, EUR/GBP could not make it lower than 0.72p following the aggressive negative reversal in futures and derivatives market. The implied volatility on EUR/GBP puts climbed significantly on longer maturity option contracts; the 6-month EUR/GBP riskies tumbled down from +31 to -38 points, the 1-year riskies from +20 to -34 pts. The real money names and macro funds have certainly been the first to rush to hedge their negative exposure to EUR/GBP. Versus the US dollar, the failure to clear offers at 1.5500/55 keeps the market skewed on the downside. A break below 1.5410 (Fibonacci 50% projection from April 21-29 rally to May 5) should pave the way to 1.5285 (200-hour MA).

UK stocks made a bullish start to the week. The Chinese policy decision will lend some support to FTSE stocks today, although we note it has not had the rocketing effect to commodity names that sometimes occurs on such a release, but the 7100 level is back in range after the risk off period around the election.

With little in the way of US data on the calendar today we could well see some profit taking following last Friday’s surge. Pre-market trading suggests that the Dow Jones will open down 30 points at 18161.