The ECB publishes its forecasts in bands. It expects growth of between -0.9% and 0.3% next year and then 0.2% and 2.2% in 2014. Thus, the lower end of the forecast is significantly worse than the OECD's forecast of a decline of 0.1% in the currency bloc's GDP next year. The news was equally bad for inflation. ECB President Draghi said that inflation is expected to fall below the target 2% in 2013 due to the weak economy and high unemployment rate. There is only a slim chance of inflation hitting the 2% target, and the Bank believes that prices could oscillate between 1.1% and 2.1% next year.
Don't hold your breath for an imminent ECB rate cut
But could weak growth and inflation cause the notoriously hawkish ECB to cut rates in 2013? Don't hold your breath. Draghi said two things which suggest that a rate cut may not be the next policy step taken by the ECB. The first thing he said was that medium-term inflation outlook was broadly balanced. Since the bank makes policy decisions based on the medium-term outlook, it may be willing to tolerate below-target inflation next year as it waits for the economy to recover. The second thing he said was that credit growth was low because of the weak economic outlook. Thus a 25 bp rate cut in the current environment may not spur extra economic activity in the currency bloc. The ECB looks firmly on hold to me unless there is a flare up in sovereign concerns, which could force them into a rate cut. Draghi has continued to pass the baton to European governments, and said he looks forward to next week's European Council meeting to form a roadmap towards "genuine economic and monetary union", no small order...
EURUSD gets thwarted once again
The weak growth and inflation forecasts have weighed on the euro this afternoon. EURUSD has fallen through key supports at 1.3040 and is approaching 1.3000. Below here 1.2980 - the top of the daily Ichimoku cloud and the end of a formal uptrend - could halt the decline in the single currency. This cross is starting to look oversold according to the hourly MACD and may experience some stickiness as we approach 1.2980.
However, in the short to medium term we expect the single currency to follow Spanish and Italian bond yields. Yields have moved higher for both countries today because 1, the ECB remains on hold, which suggests that there is no more official support waiting in the wings for the peripheral nations and 2, domestic issues including a large debt issuance schedule for 2013 for Spain and election concerns for Italy are dampening sentiment for peripheral debt. These pressures are unlikely to disappear in the medium-term, which could weigh on the single currency for some time yet. A daily or weekly close below 1.2980 would be a very bearish development for this cross and could trigger a deeper sell off to 1.2800.
More QE may not be bad news for sterling
The Bank of England stayed on hold this month, but we still think that more QE could be waiting in the wings. Mervyn King only has another 6 meetings as governor, and we think that he is unlikely to change policy direction between now and then. Thus, we expect further QE perhaps in February when the first Inflation Report of the year is released especially if growth is weak in Q4. The latest official forecasts for growth and inflation in the UK suggest that the economy could contract this quarter, if that happens then we believe the BOE may react with an injection of more QE.
Interestingly, we don't foresee the pound weakening too much further from here. The pound can be very resilient to QE and we also expect UK Gilts to continue to attract safe haven flows due to rising tensions in the currency bloc in Q1 next year. Added to this, we expect the FOMC to announce an extension of QE3 when it meets next week, which may keep a lid on dollar gains. The pound hasn't had as strong a run as the euro recently so there is some more room on the upside, in our view. In GBPUSD we could rally back towards 1.6250 in the medium-term, once the dust has settled from a very data - heavy week. In EURGBP, a fall below 0.8060 - the 200-day sma - could cause a deeper decline to 0.7950.
Sandy disruption could weigh on NFPs
Elsewhere, initial jobless claims in the US fell by 25k last week to 370k; however the 4-week moving average continued to climb after claims were revised higher for the week prior. Although the effects of Sandy are now starting to wane, its footprint may still be felt in the NFP data due out tomorrow. Watch out for our research report due out later and get our forecast for November's NFP report. The market expects 86k, which would be the lowest level of job creation since June this year.
Ones to watch: euro downside
Chart 1: EURUSD - below 1.2980 may see back to 1.2800.
IMOH, Clement I
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