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Divergent Policies from 2 Key Central Banks

Kathy Lien

Talking Points:

  • Bank of England (BoE) Minutes Due Wednesday
  • A Scenario That Could Jolt GBP/USD
  • Bank of Canada (BoC) Likely to Hold Steady

The British pound (GBP) traded higher against the US dollar (USD) on the back of stronger public sector finances on Tuesday. Net borrowing in the month of September was only GBP 11.1 billion, down from GBP 12.5 billion the previous month.

Stronger growth and higher tax receipts are helping to repair the UK's fiscal finances, and if this trend continues, the Chancellor will have no problems meeting his deficit-reduction targets.

On Wednesday, the Bank of England (BoE) will release the minutes from its last meeting. Policymakers met under the backdrop of fresh weakness in UK PMI data and US fiscal debt troubles, which may have kept all nine members of the monetary policy committee (MPC) in favor of leaving quantitative easing (QE) unchanged for the month of October.

The last time the BoE met, MPC member David Miles voted against an increase in QE, making the central bank as a whole less dovish. We don't think there are enough concerns about inflation or stronger growth within the central bank to support tighter monetary policy at this time, but if there is, it would be just what GBPUSD needs to break its 2013 highs.

Bank of Canada (BoC) Holding Steady, too

After a one-day pause, commodity currencies resumed their rise against the US dollar. The strongest gains were seen in the New Zealand dollar (NZD) and Australian dollar (AUD), but weaker economic data held back the Canadian dollar (CAD).

Canadian retail sales grew by only 0.2% in the month of August after rising 0.5% the previous month. This was the second consecutive month that spending increased, and even though growth slowed, the absolute amount of spending matched a record set earlier this year.

For the Bank of Canada (BoC), which meets on Wednesday, the pullback in spending will not be a major concern. However, the impact of the US government shutdown on growth could keep the central bank cautious.

Manufacturing activity only saw a slight improvement in the month of September, while job growth slowed. When we last heard from the BoC, it sounded more cautious about the economic outlook, but the guidance on interest rates remained unchanged.

The BoC still believes that "over time, as the normalization of these conditions unfolds, a gradual normalization of policy interest rates can also be expected, consistent with achieving the 2% inflation target."

In other words, the next move is to raise interest rates, not lower them. Still, for the time being, the Bank is comfortable with the current level of monetary policy, a view that we expect to be repeated this month.

See also: A GBP/CAD Set-up All Traders Can Agree on

By Kathy Lien of BK Asset Management

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