2 Colossal Central Bank Decisions in Focus

DailyFX

Decisive stimulus measures by the Bank of Japan (BoJ) kicked off a very large USDJPY move today, while comments from European Central Bank (ECB) President Mario Draghi will likely keep the euro grounded.

It was a very busy night in the currency markets that featured significant price moves in all the key pairs, but USDJPY undoubtedly stole the show. The Bank of Japan (BoJ) unveiled an extremely aggressive quantitative easing (QE) program that exceeded market expectations and sent USDJPY more than 200 points higher in Asian and early-European trade.

The BoJ announced that it would double its bond-purchasing program, increasing the volume to approximately $74 billion per month (JPY 7.5 trillion). It will also extend the maturity of its bonds from two years to seven years and will re-focus its efforts from targeting the overnight call rate to the monetary base while seeking to increase that figure to 270 trillion yen by 2014.

However, perhaps the most dovish aspect of the BoJ monetary policy announcement was the temporary suspension of the "bank note rule,” which pledges to keep the value of its bond holdings below the cash in circulation. Such a move signals that the BoJ is extremely serious about increasing inflation to the 2% target over the next two years. This is perhaps the key reason for the markets’ enthusiastic response to the new BoJ policies.

USDJPY quickly sliced through the resistance points at 94.00, 94.50, and 95.50 before topping out at 95.68—fully 300 points off the session lows. This bold and aggressive easing was just what the bulls were looking for, and we now believe that the correction in USDJPY is over. With the currency pair trading above 95 again, it may be on its way back up to 100.

See related: 3 New Trading Scenarios for USD/JPY

Since the start of the year, the rally in USDJPY has been driven by a combination of dovish Japanese monetary policy and better-than-expected US economic performance which helped push US yields higher.

However, the most recent economic data suggests that the US economy may be starting to stall, which is why this Friday's non-farm payroll (NFP) report could be critical to the future direction of USDJPY.

With markets already tempering their expectations, any NFP print near the 200K level would be seen as bullish and could propel USDJPY to fresh yearly highs. However, if the data disappoints, the pair could stall at current levels despite the herculean efforts by the BoJ to further weaken the yen.

The Critical Takeaway from Today’s ECB Meeting

Meanwhile, in Europe, the economic data continued to show further contraction as the final GE services PMI printed at 50.9 versus 51.6 expected. The news weighed on the EURUSD, which dipped below the 1.2800 level in morning European dealing.

The market’s full attention, however, was on the European Central Bank (ECB) meeting, where comments from ECB President Mario Draghi sent the EURUSD lower.

As expected, the ECB left interest rates unchanged at 0.75%, but the real action was during Draghi's post-meeting press conference, during which he assessed economic conditions and tipped the Bank’s hand with respect to future monetary policy.

While most of Draghi’s comments were unchanged from last month, his concern about the downside risks in the second half and admission that the ECB will continue to assess incoming data and stand ready to act indicates that the central bank is still open to idea of additional easing.

That said, another rate cut remains on the table, and as long as that's the case, EURUSD is likely to have a tough time recovering.

Let’s not forget that while the ECB and Federal Reserve are both currently engaged in aggressive monetary easing, the ECB is considering the need for increased stimulus, whereas the Fed is considering when and how to taper off its asset purchases.

This divergence in the potential direction of monetary policy between the two central banks should play a key role in the outlook for EURUSD.

The key takeaway from Draghi's comments today is that they haven't shut the door on additional easing. The ECB's concerns center on weak consumption and failed structural reforms, but Eurozone growth should benefit from a recovery in global demand…if that ever happens.

We believe that the downside risks for the Eurozone are realistic and likely to increase in the coming months, especially if global equities correct lower.

The selloff in the euro moderated when Draghi said the problems in Cyprus reinforced the central bank's determination to support the currency, and while Cyprus is "no template" for a future bailout, these comments suggest that the ECB will be quickly involved if another country were to face the same problems.

Draghi also took the opportunity to push the idea of a single supervisory mechanism (SSM), which would lay the foundation for a banking union best-equipped for preventing a similar crisis.

It's clear that Eurozone officials must do something to stimulate demand, as austerity has been an abject failure in the periphery and the slowdown is now making its way to the core, with France in full-blown contraction.

The EURUSD has been remarkably resilient in the face of negative news, however, and Draghi’s comments today may help the pair dodge a decisive fall beneath support at 1.2750 as the day progresses.

By Kathy Lien and Boris Schlossberg of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
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