The Bullish Case for GBP?

"From the errors of others, a wise man corrects his own.” - Publilius Syrus

So European Central Bank President Trichet disappointed those looking for an interest rate cut but delivered just about everything else. The announcement of a reopening of covered bond purchases to the tune of EUR40 billion and the introduction of two one-year LTRO financing operations was a huge commitment to the ‘separation principle’ whereby the distinction between liquidity provision to the financial system is clearly ‘separated’ from the core function of interest rate, or monetary policy under the ECB's sole mandate of price stability. 

Ultimately in expanding the separation principle and throwing all but the kitchen sink at liquidity in the financial system, Trichet has maintained both the credibility of the ECB and himself, giving some interim support to the EUR (at least until the focus comes back on the Eurozone political leadership’s efforts to contain the Sovereign Debt crisis). The surprise uptick in inflation in the Eurozone at the last time of asking (driven largely by 0.5 percentage points annualised increase in German inflation) highlights the fact that cutting rates clearly didn’t sit comfortably with what was a consensus (but not unanimous) view of the governing council.  

BOE's QE and Moody's downgrade of UK banks
Arguably though, the big news of the day was the surprise move to re-open the electronic printing presses in the UK. The Bank of England’s Quantitative Easing programme was increased by GBP75 billion to GBP275 billion in a move that Mervyn King described as “pre-emptive action to try and prevent the slowdown from becoming too serious”. 

This I feel is a very important nuance to the actions of the Central Bank. King was also specific in his rationale that loosening monetary policy further was necessary because “the impact of the rest of the world on the U.K. does threaten our recovery”. Banking liquidity has clearly become a significant issue and one which has driven the actions of messrs Trichet and King into further stimulative action (whilst taking different paths to achieve it). The downgrading of 12 U.K. banks by rating agency Moody’s this morning highlights the concerns, as does the growing amount of deposits from Eurozone banks placed at the ECB, when lending to other banks would earn significantly higher returns. 

GBP to outperform?
Whilst in the short term GBP has suffered on foreign exchange markets I feel that there is now a case for GBP to outperform. The pre-emptive action of the Bank of England in light of what is ultimately a global downturn in confidence and a result of significant risks in the global economy – primarily the Eurozone (as King clearly stated yesterday) – should underpin the U.K. economy and GBP going forward. Particularly against the EUR and in that sense I still see any rallies in EURGBP as offering value. 

US jobless data in focus
For the day however, the focus of market attention will likely be on the US employment report and with economists estimates of the headline payroll change at a low level (55k) the risks are that we get a slightly more positive number (although unlikely to be enough to warrant any serious comfort at the fed – above 200k is widely thought needed to stabilise the unemployment rate).  Ultimately that means that for the day, the USD will likely remain on the back foot and risk assets will continue to outperform. Next week however may be a different matter altogether!