Research Note: March 5, 2009 BOE and ECB Rate Decisions

Bank of England: At 0700ET on Thursday, the BOE MPC will announce its interest rate decision and may release an exchange of letters between the BOE and the UK Treasury that may spell out quantitative easing measures the BOE may undertake. Consensus forecasts are for a 50 bp rate cut from 1.00% to 0.50%, though overnight markets are only pricing in a 37 bp rate (100% chance of 25 bps/ 50:50 chance of another 25 bps). Given past BOE concerns over the effect of rate cuts on GBP, we think the BOE will cut only 25 bps, but then assuage concerns by announcing a large asset purchase program as part of its quantitative easing. We think GBP will benefit both from the smaller rate cut and the ongoing, proactive measures taken by the BOE and the government to stabilize the financial sector and support domestic consumption. European Central Bank: At 0745ET Thursday, the ECB is expected to announce a 50 bp rate cut from 2.0% to 1.5% and we agree with that consensus. However, we think the outlook for the Eurozone economy remains negative and that the ECB will be compelled to cut rates further in the 2Q. Additionally, lingering concerns on western European banks' exposure to Central European and Latin American borrowers and the relatively stingy response from Eurozone governments to the recession expose the EUR to greater downside risks. ECB Pres. Trichet will likely accentuate the negative at his 0830ET press conference and in response to reporters' questions, and we would look for the EUR to weaken as a result. Trading Strategy: Given our views that the BOE rate decision will be supportive for GBP and the ECB rate decision will be negative for EUR, the clearest trade for tomorrow is to be short EUR/GBP going into the decisions. However, we are likely not alone in our thinking and the risk is that short EUR/GBP positions become excessive in the run-up to the announcements and are subsequently squeezed out just before or after the announcements. With that in mind, we would go into the releases short only a small EUR/GBP position, ideally in the 0.8950/60 area, but look to sell any rallies into the 0.9000/0.9020 area. EUR/GBP is currently trading below its Ichimoku cloud (base at 0.9019) and below the Kijun line (0.8994), but above the Tenkan line (0.8870). Weakness below 0.8870 may see a decline to the 0.8810/15 lows seen to start this week. Against the USD, it's a much trickier call and we will stick to EUR/GBP. In general, though, we think that the overall risk on/risk off trade is likely to dominate USD-pair movements. If stock markets are doing well or respond favorably to the rate decisions, then we would expect the USD to weaken and for EUR/USD and GBP/USD to move higher, but for GBP/USD to outpace gains in EUR/USD. If shares are weak or disappointed by the rate decisions, we would expect the USD to strengthen and for EUR/USD and GBP/USD to both decline, but with EUR/USD falling farther than GBP/USD. Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.