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Forex Market Analysis

Forex and Indices – Daily Update – 13.07.18


Fundamental Forex Trading Overview


BoE’s Deputy Governor Cunliffe suggests a delay in a rate hike.

The Bank of England’s (BoE) Deputy Governor, Sir Jonathan Cunliffe, said on Friday that we should be cautious in an interest rate increase and that there are still arguments for a “stodginess” policy. Cunliffe suggests a delay in a rate hike due, despite the economic growth, to the wage rate is not increasing to the 3 per cent that the BoE had initially forecasted.

The BoE’s next Monetary Policy Committee meeting will be on August 2, for this meeting most economists polled expect the rate to increase.

 


Technical Analysis


 EURUSD

The EURUSD in the 2-hour chart is bouncing from the Potential Buy Zone as expected in our previous Daily Update on Thursday 12th when we commented that EURUSD was making higher highs and higher lows. Now when the pair is testing support in the green box, we expect new upsides to 1.19067 (orange box – maturity area) completing a major degree connector. Invalidation level is 1.15080.


 

GBPUSD

The GBPUSD in this 2-hour chart is completing a new bearish leg in the Potential Buy Zone. We foresee a breakout of the short-term trendline and the continuation of the previous bullish cycle with a target placed in the 1.3475 area. Also, the exhaustion area is the target area of the inverted head and shoulders pattern which will be active once time the short-term pivot level was surpassed. Invalidation level of the new bullish cycle is 1.30494.



 

USDCHF

As noticed in our last Forex and Indices daily update, the Swiss currency is being the weakest currency. The USDCHF in the 2-hour chart soars to the highest level since May 2017. Using the correlations in the US Dollar group with DXY, EURUSD and GBPUSD, we could suspect that this is a false breakout.


 

EURCAD

The EURCAD cross in the 2-hour chart has broken down the short-term pivot level at 1.53684 and made a pullback to the same level turning the support into resistance. We expect more falls with a target placed in the area between 1.5144 to 1.5061. Invalidation level is 1.55225.



GBPCAD

The GBPCAD cross in the 2-hour chart is consolidating testing the 1.73 psychological support level. It is likely that the price moves bullish making a false breakout before to continue the previous bearish impulse. Invalidation level is at 1.76907.



FTSE 100

The FTSE 100 in the 2-hour chart continues to consolidate, developing a complex corrective structure and testing around the 7,700 level. We foresee a limited upside for the British index to 7,792 pts. Invalidation level is 7,508.



DAX 30

The DAX 30 in the 2-hour chart is moving bullish, testing the 12,600 pivot level. We expect more climbs to the area between 12,695 to 12,742. The critical level to watch is the 12,807 pts, from where if the price surpasses it, DAX could rise to 13,020 pts. Invalidation level is 12,104.



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Forex Educational Library

Report of the Financial Policy Committee June-November 2017

The Financial Policy Committee (FPC) was established in 1998 and amended in 2012. The main objective of the committee is to ensure the financial stability of the United Kingdom, which is one of the fundamental pillars of the Bank of England. In addition to supervising the health of the financial system, it must also aim at the good development of the economy by supporting other committees and the objectives of the Crown that are based on growth and employment. The responsibilities of the committee are mainly to identify, monitor and take necessary actions to remove or reduce the systematic risks of the financial system of the United Kingdom.

The Financial Policy Committee (FPC) has the objective of ensuring that the financial system of the United Kingdom is resistant to the various risks and situations that they may face over time. The FPC evaluates internal and international risks and is always monitoring variables such as credits, mortgages and others so that they are within an acceptable range for the committee.

In recent years in the UK, consumer credit has grown rapidly. The conditions for access to a mortgage have become more accessible so it is easy to think that there are negative incentives for bankers who often prioritise their economic benefits and profits of the banks before the security of the financial system.

Another concern of the committee is Brexit. This event has generated much uncertainty in international markets and is still unclear on what will be the conditions of the departure of the United Kingdom from the European Union. This is a concern because it is clear that the financial system will be affected when Brexit is completed.

On the other hand, in the June report, the Committee observed that many of the global risks had not materialised which was a relief to the financial system and the economy of the UK, but they continued to observe vulnerabilities in the Chinese financial system, so they were still analysing the situation in China. For the FPC, market volatility measures and the valuation of some assets such as corporate bonds and UK real estate did not seem to show signs that investors had these global negative projections within their valuation models, in addition to very low interest rates which affected long-term assets.

To maintain the soundness of the financial system and avoid possible future risks, the bank decided to increase the UK countercyclical capital buffer (CCyB) rate to 0.5% from 0% Also, the FPC expected to increase the rate to 1% at its November meeting. The countercyclical capital buffer (CCyB) is a tool that enables the FPC to adjust the resilience of the banking system. The FPC increases the CCyB when they consider that risks are building up. The bank forces commercial banks to have more capital reserves to face possible economic or financial shocks, absorbing the losses which makes a stronger financial system and prevents bank failures.

The bank performs multiple stress tests of the economy, taking different scenarios to analyse what the response of banks and the financial system would be in general, to study what possible measures can be taken to reduce the risks to which the system is exposed. The bank’s annual stress test assesses the banks’ resistance to consumer credit risks. Due to the rapid growth of consumer credit in the last year, the FPC began to perform stress tests analysing what the possible losses of the banks could be if a problem was found in the local economy.

Credit card debt and personal loans were the main variables that increased rapidly. But the committee noted that the losses in consumer loans were low and the loan environment was good so there was a large number of loan offerings. The downside is that the maturity of the loans was very short, so the quality of the loans could go down drastically and very quickly.

The Brexit negotiations had already begun before the June meeting and the bank had very broad expectations about the possible paths that the negotiation could take, so there was no clarity about the possible steps to follow. To be prepared, the FPC had a contingency plan to reduce the financial risks derived from Brexit as much as possible.

Spreads on sovereign bonds in the Eurozone had declined due to the resolution of some political uncertainties. In China, the outflow of capital had stabilised but the economic growth of the country was still based on a very rapid expansion of credits, which made it a risky scenario due to possible problems in the financial system. In the UK, yields on 10-year government bonds were close to -2% and in general, in the G7, long-term interest rates were low, which was evidence of negative growth expectations in addition to the uncertainty of the investors. The above can be seen in the following graph.

 

Graph 48. International ten-year real government bond yields. Retrieved 27th January 2018, From https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-report/2017/june-2017.pdf?la=en&hash=F7350AAAC8F5F268B43FE25A9CE0CDADAB8A2E79#page=9

 

It is evident in the FPC reports that the main local concern is Brexit. This is because there are many companies and banks that could leave and stop operating in the UK because of the regulation changes after the negotiations, there could be changes in the rules which would affect the margins of the companies, make contracts again or relocate resources which could be costly. The withdrawal of the United Kingdom from the European Union has the potential to affect the economy through the supply, demand and exchange rate channels.

In global financial markets, the uncertainty measures implicit in the prices of the options were low. In June, the VIX measure of implied capital volatility derived from the prices of the S&P 500 stock index options had reached its lowest level since 1993. The Committee noted that, often in periods of low volatility, the risk increases, and then they become evident.

As previously mentioned, long-term risk-free interest rates in advanced economies remained low, which is consistent with pessimistic growth scenarios and a great uncertainty of the global situation is perceived. As for short-term expectations, they improved in the last period despite the fact that world average growth was lower compared to the pre-crisis period.

The committee argued that the prices of global assets were vulnerable due to possible increases in long-term interest rates or adjustments in growth expectations. Regarding the exposure of the UK banks to the real estate market, positive signs were found because the exposure to this market was reduced to half of the figures seen before 2008, making the financial system more robust, at least in this aspect.

The UK banking system continued to strengthen its capital positions due to the valuation of different metrics in addition to the results of the stress tests, so the committee concluded that the system was well capitalised, with good liquidity and good financing coverage.

The June report concluded that the recovery capacity of the UK financial system had strengthened significantly since the crisis and is capable of absorbing shocks to the real economy. The future of the economy was expected to be full of risks due to events such as, risks in China, negative expectations and mainly due to uncertainty about the completion of the Brexit talks, but the FPC promised to carry out all the possible studies to have greater clarity about what awaited the UK after leaving the European Union, and taking the necessary measures to maintain a robust financial system and good growth rates.

The following graph shows the comparison of the main debt metrics, market conditions and the balance sheet of the bank. As it is observed, the values up to the June meeting did not show high risks being within the values seen historically.

Graph 49. Core indicator set for the countercyclical capital buffer. Retrieved 27th January 2018, from https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-report/2017/june-2017.pdf?la=en&hash=F7350AAAC8F5F268B43FE25A9CE0CDADAB8A2E79#page=9

 

At the November meeting, the FPC raised the UK countercyclical capital buffer rate from 0.5% to 1%. This measure was taken by the bank due to the results obtained in the stress test where some risks were observed, so it was decided to raise the rate as a precaution.

In November, the FPC continued to observe Brexit as a major risk, some risks in the domestic economy and global risks were due to some erroneous asset valuations. But despite these risks, after the stress test of the financial system, the FPC concluded that the system was robust and could support the economy in case of a disorderly Brexit that would lead some variables to show negative trends such as employment, the real estate market and even an aversion to UK assets. If the worst-case scenario were to occur for the British economy, the financial system would have the strength to support economic recovery and not collapse.

The conjuncture that could generate a crisis in the banking system would be a messy Brexit and a severe global recession. In this scenario, it would be possible to generate a credit restriction for new loans because the capital of the banks would be threatened, so the financial system would not be able to support the economy.

Regarding local conditions, it was observed that the main variables were within normal parameters without any excessive risk, although the committee must continue to monitor the system, especially due to the high level of indebtedness in the economy. The credit growth rate was above the nominal GDP growth, but there was no evidence of excessive risk at the moment. The following graph shows that consumer credit was not at alarming levels.

 

Graph 50. Outstanding consumer credit to income. Retrieved 27th January 2017, From https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-report/2017/november-2017.pdf?la=en&hash=8CB2A5526478872DE14D531254B948BB6FD47793#page=9

As already mentioned, if after Brexit, investors stop acquiring British assets, this could affect the financial system which would reduce the number of loans granted to people, which would have an impact on the economy and could affect the economic growth of the country in the short term.

Regarding external factors, the committee explained that the current account of the UK has been in deficit persistently since 1999 and has increased since 2012 reaching 4.6% of GDP in the second quarter of 2017. It has been increased mainly by lower profits from foreign direct investment.

Long-term global interest rates have remained near historically lower levels. This has been evidence of structural factors such as demographic changes and expectations of low inflation despite solid but moderate growth. As in June, the committee observed worldwide investors have placed an excessive weight and optimism in current economic conditions, and have not correctly assessed the medium-term risks which have created a risk in the global financial markets, which in future may come to affect the British financial system.

In the corporate bond market, spreads were at levels seen before the financial crisis with a more compressed high yield, compared to historical levels. This has come along with greater leverage of companies in the United States. In the UK, there is a high risk that economic growth will be weak, so the UK’s risk-free rates have been falling since mid-2016 compared to other economies.

Short-term expectations have improved in terms of global economic growth with better prospects for the IMF by the end of 2017. The better prospects were given by better behaviour in the Eurozone, Japan, China, Russia and emerging Europe. Despite these better prospects, the FPC observed some vulnerabilities in some financial systems and markets due to a significant increase in the debt of non-financial sector companies as part of the GDP at previous levels of the 2008 crisis, especially in China where the debt has grown about 60% in the last 5 years. Finally, on the international scene, the government confirmed its intentions that by the 29th of March 2019 the United Kingdom must have completed its negotiations to leave the European Union and establish trade negotiations after it no longer belongs to the economic union.

In conclusion, the Financial Policy Committee is very explicit about which risks will be faced by the financial system and how the committee is prepared to face them by taking the respective measures. In the last two reports, the committee focused on the same risks at the local and international level, taking the Brexit negotiations as the main risk for the United Kingdom, which could lead the financial system to limit its offer, which could affect British growth. They also emphasise that the interest rates of developed countries have remained low due to not so optimistic expectations of the countries, in addition to the fact that inflation has remained low. This is a recurring theme in the reports of the central banks of the United States and England because they have not seen entirely positive behaviour in inflation and in growth, so when they have been making monetary policy decisions they have been very cautious.

Based on the FPC report it is also evident that there is an optimism among investors worldwide that has prioritised current conditions but has not valued the global economic risks such as excessive Chinese companies’ debt and some geopolitical conflicts, whereby markets and financial systems are exposed to a risk given the overvaluation. This represents a threat to global economic growth and especially to the United States where the large rise in stock market shares has generated households with greater wealth. This has encouraged consumption and in turn, this has boosted economic growth, but the overvaluation of assets could affect the economic growth since it affects the main engine of the economy.

China also represents a global risk because it is the second-largest economy, so if a crisis occurs in the financial system, domestic consumption would decrease drastically and exports around the world would be affected. It is perhaps the most latent risk internationally for developed countries that could trigger other risks such as falls in stock market indices and contagion in global financial systems.

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Forex Educational Library

The Bank of England

Bank of England

The Central Bank of England is in charge of dictating the monetary policy of the country through a specialised committee. In addition to ruling the monetary policy of England, it also serves as the central bank of the government of the United Kingdom. Although it belongs to the European system of central banks, it has full autonomy from monetary policy due to the non-adoption of the Euro as a national currency. It is located in London.

The governor of the Bank of England is the most important position within the Bank of England as it belongs to the monetary policy committee and therefore has a predominant role in the orientation of national economic and monetary policies. The bank of England is the UK’s central bank. The mission of the central bank is to promote the good of the people by maintaining monetary and financial stability. The bank of England has four basic functions:

  • Regulate other banks
  • Issue banknotes
  • Set monetary policy
  • Maintain the financial stability of the system

One of the most important tasks of the central bank is to design and print banknotes. Only the central bank of England can issue banknotes in England and Wales, but seven commercial banks can issue them in Scotland and Northern Ireland. The Bank of England is responsible for keeping the UK’s economy healthy through an adequate monetary policy. The bank has two main tools to intervene in the economy by moving the interest rate (formally known as Bank Rate) and in special circumstances using Quantitative Easing (QE). Decisions on monetary policy are made by the Monetary Policy Committee (MPC) eight times a year.

Also, the Bank of England is responsible for the surveillance of the financial system. The Financial Policy Committee (FPC) identifies and monitors risks in the financial system and intervenes to reduce or remove these risks. Among other tasks that the bank has, it is responsible for conducting studies and research on the state of the economy, regulate and supervise other financial institutions.

The governors of the Bank of England perform at one of the highest levels of the executive team and are jointly responsible for the bank’s policy committees to achieve the bank’s mission of providing stability to the British economy and its population. The governor together with various committees and the court of directors are responsible for studying the behaviour of the British economy and making decisions depending on the tasks of each committee.

The Court of Directors acts as a unitary board setting the strategies of the bank’s organisation and budget, in addition to making key decisions about the appointments in the bank and the resources of each area and committee in the bank.

The Court is required to meet at least seven times a year and has five executive members of the bank and up to nine non-executive members. All members of the court are appointed by the crown and one of the non-executive members is selected by the chancellor to preside over the court. The governor serves the court for a term of eight years, deputy governors for five years and non-executive members for up to four years.

In addition to the meetings of the directors of the court, the court is assisted by other committees each with specific tasks that they have to comply with and assist the court in the management of the bank. Since the foundation of the bank in 1694, the directors of the bank have met regularly to discuss various issues related to the administration and operations of the bank. Since 2012 the financial service minutes mandated the board of directors of the court to publish the minutes of the meetings a few weeks after each meeting they held.

Although the mandate was established in 2012, minutes of the meetings have been kept in the bank’s archive since the first one in 1694 in London. To access the minutes of previous meetings the bank decided to digitise minutes dating from the late twentieth century thus facilitating the investigations of investors and academics on the decisions taken by the central bank.

One of the aspects that most worries central banks in the world is the behaviour of inflation because this variable affects transactions, the wealth of households and often also determines the behaviour of the labour market. Inflation is calculated by the central bank through a team of specialists from the national statistics office, which collects price information from the goods and services market, forming a basic consumption basket. That basket of goods is used to calculate the consumer price index (CPI). The statistical office publishes the change of this index every month.

The central government of England is the one that dictates what will be the annual inflation target that the Bank of England should sustain in order to achieve the proposed goals regarding the number of employees and the welfare of the population. The government has set the target at 2%.

To achieve this goal of 2% there is a committee in charge of dictating the monetary policy called the Monetary Policy Committee (MPC). This committee is in charge of changing the bank’s official interest rate. This is the rate that the central bank pays for maintaining the reserves of commercial banks and generally the change of that rate is transferred to consumers. When the rate goes up by the central bank, commercial banks pay more for people’s savings, but they also raise the cost of loans and other financial products such as credit cards.

The logic of the bank is that if inflation is above the target level, interest rates are raised so the loans and credit card consumption is reduced, affecting consumption by the people, which will lead to inflation decreases. The same happens in the opposite case, if it is necessary to encourage greater consumption so that inflation rises, the rates are lowered to encourage spending by households and businesses. There is a mandate from the bank where if the rate of inflation at the end of the year is above 3% or below 1%, the governor of the Bank of England must deliver a letter written to the chancellor explaining why the bank failed in its goal of 2%, and what measures will be taken to meet the goal the following year.

The monetary policy committee is responsible for making decisions about how and what tools to use to achieve the inflation target. Historically the Bank of England has used the interest rate, but recently the bank has tried to use quantitative easing to stimulate the economy and reach the target inflation rate. Reaching the inflation rate proposed by the government is the main objective of the monetary policy, but there are also other objectives such as serving as support to the government objectives in terms of economic growth and the unemployment rate.

The monetary policy committee (MPC) is composed of nine members: the governor, the three deputy-governors for monetary policy, financial stability and markets and banking, a chief economist and four external members appointed by the chancellor. These external members are appointed to ensure that the MPC has a diversity of thoughts and experience of members who do not belong to the bank.

Also at the meetings of the MPC is a representative of the HM Treasury who cannot vote on the decisions of the committee, but can discuss what would be the best decisions they could make in monetary policy. MPC members serve by fixed terms and after their cycles are completed they are replaced or re-elected.

In conclusion, the objective of the MPC is to maintain price stability within the United Kingdom and to support government policies to encourage growth and good job creation rates. The bank has several tools such as the interest rate and the volume of purchases of assets financed by the issuance of bank reserves and exchange intervention. The MPC has no responsibility with respect to the risk profile of the Bank’s balance sheet, that responsibility falls on the Court of Directors, or the Court may delegate it to the Governor and the Bank Executive.

The MPC has no responsibility with respect to the provision by the Bank of financial assistance to financial institutions. That responsibility also falls to the Court of Directors (or may be delegated by the Court), although the Financial Policy Committee may make recommendations on the Bank’s provision of collective assistance.

The Financial Policy Committee (FPC) identifies, monitors and takes the necessary measures to eliminate or reduce systemic risks to protect and improve the financial system of the United Kingdom. The financial policy committee was established in 2013 as part of a new regulatory system that was imposed to improve financial stability after the global financial crisis that occurred in 2008. The financial committee normally has thirteen members. Six members are staff of the Bank of England, the Governor, four deputy governors and the Executive Director of Strategy and Financial Stability Risk. In addition, there are five external members who are selected for their experience in, and knowledge of, financial services.

Another committee of the Bank of England is the Prudential Regulation Committee (PRC). The PRC makes the prudential regulation authority’s most important decisions. The PRC is made up of twelve people. It is chaired by the Governor of the Bank of England and the other four members are Bank England Deputy Governors. A positive aspect of the committee is that the majority of the members came from outside the bank.

In addition to the aforementioned committees, the Bank of England has a network of twelve agencies located throughout the United Kingdom. These agencies play an important role in linking businesses, people and local economies with those in charge of monetary policy and other committees belonging to the bank in London. The agencies are responsible for the central bank to ensure that its economic prospects are correct because they are more in contact with the market than the bank is.

Each agency is composed of four agents and an administrative team. These agents have face-to-face conversations with people, businesses and some industries located near each agency, as well as attending local events to find out what the agents’ perspectives are on the economy.

Each agency has a network of contacts with those who can talk regularly but who belong to organisations from all sectors of the economy, so they have contact with a wide range of companies, ranging from small companies to multinational companies with each agency.

After these meetings with each major agent in each area, the agencies share their information with the Bank of England to take these reports into account at the monetary policy meetings, the financial policy committee and the prudential regulation authority. In addition to this good organisation, each agent can schedule meetings with local agents with the people belonging to each committee so that they can hear the information first-hand.

The bank publishes the agents’ findings eight times a year, but they do not necessarily share the opinion of the agents, just as the committees do not always act solely based on these reports. In recent years each agency has been collecting greater amounts of information for the bank to be more efficient in its mandates and try to create a more robust and more stable system.

There is evidence that indicates that these agencies have been efficient in their work in terms of information that has managed to warn the bank of risks in the corporate credit market, and abnormal conditions in the real estate (housing) market.

Finally, it is important to clarify what the role of the HM treasury member is and to identify why they are always present at the meetings of the MPC and in the monetary policy decisions. The HM Treasury is the government’s ministry of economy and finance and tries to control public spending, direct the economic policy of the United Kingdom and make decisions that help sustain strong economic growth.

As already mentioned, this entity oversees:

  • Public expenditure: departmental expenses, public sectors and pensions
  • Financial services policies: Regulation of financial and banking services, financial stability and ensuring the competitiveness of the system
  • Strategic supervision of the UK tax system

The priorities of the committee are to achieve a strong and sustainable economic growth, reduce the deficit of the trade balance of the economy, ensure good management of taxes, try to have an efficient and simple tax system, among others.

In conclusion, the Bank of England is one of the most efficient banks in the world due to its different committees and agencies that allow its governors and directors to be in permanent contact with market agents and the perspectives of people who face the local conditions daily. In addition, in its committees, there are members external to the bank which allows adding more knowledge to the discussions and different perspectives of the internal members of the bank, so there are different profiles in the members of the committees. In addition, the bank is independent of the government as is the case for most of the central banks of the world which gives greater flexibility when acting.

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