Notes From Underground

Tomorrow brings two central bank interest rate announcements. First, at 6:00 a.m. CST the Bank of England will deliver its last decision under the guiding hand of Governor Mervyn King. Consensus calls for no change in the 0.50% lending rate or the current BOE asset purchase program. Governor King has been in favor of increasing the quantitative easing amount but has been outvoted by his board three consecutive meetings. It would be silly to affect a policy change before the new governor takes his place. Forty-five minutes later, the European Central Bank will announce its decision and it is expected to hold rates at 0.50%–the ECB cut its rate by 25 basis points at its last meeting.

More important will be the Mario Draghi press conference at 7:30 a.m. The Draghi press conference is carried live over the Internet and can be found via the ECB website. The European press corps isn’t sycophantic like their American brethren and ask very good questions. President Draghi is very adept at avoidance but it is always worth a listen. Most of tomorrow’s questions will probably be directed at Draghi’s efforts to reignite a dormant asset-backed security program for the financial system. The problem that the ECB has to contend with is a financial system in which the banks are burdened with a vast array of NON-PERFORMING LOANS. The debt-plagued banks don’t have the free capital to lend to small and medium size businesses. They need to unburden themselves by packaging the “troubled” loans into a security and passing the crap to the ECB, turning the central bank into a massive bad bank.

The problem for Draghi is that it’s the Germans who must be the co-signer for lending against the questionable ABS paper. The only thing making the ECB credible at this moment is the perceived financial strength of the German economy and its guardian, the Bundesbank. Next week the German High Court meets to determine the legality of the ESM and other bailout programs crafted by the European Central Bank. Draghi will not want to wave a red cape and raise the ire of the German Constitutional Court by announcing a new leg of a European bailout. The press conference will be informative as the European opera continues to play out and the role of Castrato will be sung by the Italian, Mario Draghi.

***The Reserve Bank of Australia (RBA) held its rate steady at 2.75%, which was not a surprise. What was of interest was the line in the policy statement that  “…  the Australian dollar remains high considering the decline in export prices that has taken place over the past year and a half.” This is a very telling view for Governor Stevens. He does not want the Aussie economy to suffer from “DUTCH DISEASE.” He is afraid that the natural resource base has driven the AUSSIE too high and it is making other parts of the Australian non-competitive.

The Netherlands suffered that problem when large natural gas was discovered in the 1970s and drove the Dutch guilder to very high levels of appreciation and harm the rest of the Dutch economy. If commodity prices continue to fall over the next two months look for the RBA to significantly cut interest rates prior to the September election. Poor economic data will keep the Aussie dollar under pressure to the downside.

***Something to closely watch: The Brazilian Central Bank raised interest rates an unexpected 0.50% in an effort to curb recent rising inflation. This was done even though the Brazilian economy has been slowing. Yesterday, the Brazilian government announced that it was removing the 6% tax on foreign bondholders. (The IOF TAX was instituted to curb the inflow of international hot money.) The combination of the rate hike and the rescinding of the tax should have put a strong bid to the BRAZILIAN REAL, but the currency failed to strengthen. This may be telling about the global financial sector becoming less risk-oriented. Get out your charts and watch for important technical levels in the Brazilian currency. Attention is critical to possible sea change in psychology and the emerging markets efforts therefore to attract capital.

Tags: ABS, Australian dollar, BOE, Brazilian real, ECB, Mario Draghi, Mervyn King, non-performing loans, RBA

This entry was posted on June 5, 2013 at 8:34 pm and is filed under Central Banks, Currency. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.