Make or break week for E.U. debt crisis

Outlook for central bank decisions: RBA, BOC, RBNZ, BOE and ECB

Five major central banks are making rate decisions next week. The RBA is up first with a decision due out on Tuesday afternoon local time Downunder. Market consensus is nearly evenly split between those looking for a steady 4.50% rate and a 25 bp cut to 4.25%. Consumer inflation expectations have recently moderated to back within the RBA’s desired range at 2.5%, and given global market tensions, I would not be surprised to see the RBA cut. But it’s a close call as growth remains resilient. I would look for AUD to trade more in line with overall risk sentiment next week based on Eurozone developments outlined above.

The Bank of Canada is expected to hold rates steady when they announce Tuesday morning and BOC policy should stay on hold for the foreseeable future. The RBNZ announces on Wednesday evening ET/Thursday morning Wellington, and they are also expected to hold steady, with recent strong growth being offset by global tensions, postponing a rate hike into 2012. The BOE is up first on Thursday morning ET and the benchmark rate is expected to stay on hold at 0.50%, but the risk is that the MPC doves respond to deteriorating outlook and increase the amount of QE, last at GBP 275 bio.

The ECB decision on Thursday morning ET will be the highlight of central bank meetings for the week. The ECB is widely expected to cut rates by at least 25 bps to 1.00%, with many calling for an emergency-type 50 bp cut to 0.75%. I think the ECB will proceed more calmly and cut only to 1.00%. The ECB is also expected to undertake a number of additional measures to support banks’ liquidity; in particular I am looking for the introduction of additional long-term repo operations (LTRO’s) for 2 and possibly 3 year terms, and an easing of collateral conditions for ECB lending. The ECB is also likely to acknowledge the further deterioration in the economic outlook and perhaps to even suggest that deflation is now on the horizon. I would expect the ECB decisions to weigh on EUR overall, but again EU Summit and debt market developments will likely be more significant for the single currency. Overall, though, I would expect to see EUR decouple from recent high correlations to risk assets like stocks, but in asymmetric fashion (risk off, EUR weaker/risk on, EUR not necessarily stronger).

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