SNB discontinues cap, UK inflation at 0.5%, German growth accelerates

Source: Dukascopy Bank SA
The previous week was full of unexpected events that shocked financial markets and analysts. Like a bolt from the blue, the SNB decided to discontinue keeping its three-year-old cap of 1.20 franc per Euro and slashed its deposit interest rate to –0.75%. The decision came just one week before the European ECB board members meet to discuss government bonds purchases, which may increase pressure on the Swiss Franc versus the Euro. The SNB spent billions defending its minimum exchange rate but gave up trying to limit the Franc's appreciation in light of outright deflation and prospects of further weakening of the Euro. Following the announcement the Franc skyrocketed as much as 40% to 84.17 centimes per Euro, the highest level on record. However, further cuts in the interest rate makes the Swiss Franc investment less appealing and thus "will mitigate the effects of the decision to discontinue the minimum exchange rate", the SNB Governor Thomas Jordan said. What is interesting is the fact that only one month ago, when the central bank introduced a negative deposit rate, Jordan reiterated the pledge to defend the cap with "utmost determination". However, the SNB came to a conclusion that keeping the minimum exchange rate for the Franc against the Euro "is no longer justified". This is due to the fact that monetary policy divergence of the major currency areas is likely to become even more pronounced, pushing the Euro lower versus the Greenback, and this in turn has triggered declines in the Franc against the US Dollar.
Another shock came from the UK, where consumer inflation fell more than expected in December, forcing the BoE Governor Mark Carney to write an official letter to the Chancellor George Osborne, explaining why consumer prices have been rising to slow recently. The last letter to the chancellor, which the central bank is legally obliged to write in case inflation strays more than 1 percentage point in either direction from the official goal, was written by then Governor Mervyn King in February 2012, when price increases were running above 3%. No letter has ever been triggered by inflation falling below the threshold since the BoE became independent in 1997. The UK's inflation rate dropped to 0.5% in December on an annual basis, the lowest level in 14 years. Economists believed that further declines seem likely, making the scenario playing out in the Eurozone, where deflation has become a headache for policy makers, possible for the UK's economy as well.
Germany posted a mixed data in the week ended January 16. The Euro zone's number one economy considerably accelerated its annual economic growth over the previous year. Nevertheless, the overall pace of growth remained below the booming recovery years of 2010 and 2011. German gross domestic product expanded 1.5% over 2014 on an annual basis, more than the 0.1% growth seen a year ago. However, positive growth data would not be enough to change ECB policy makers' mind concerning the necessity of further stimulus measures and prevent the Euro from falling, as growth in the currency area remains weak. According to the Bank of France Head Christian Noyer, 2015 is set to be a good year, as falling oil prices and weaker Euro will provide support to the fragile economy of the bloc. However, Noyer stressed a need of implementation of reforms required for growth to return. Another warning sign came on Friday, as German consumer inflation fell to a dangerously low level in December to 0.2%.
Finally, the European Court of Justice gave a non-biding opinion that the ECB's OMT programme is legal and compatible with the European law, despite the fact that the scheme's legitimacy was questioned by German economists and politicians.  The opinion from Pedro Cruz Villalon, an advocate general with the European Court of Justice, is preliminary before the court's judges come to a decision later this year. The court does not have to necessarily follow his opinion. Nevertheless, it might also ease resistance to a similar programme that could be announced by the ECB Governor Mario Draghi as soon as January 22.

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