Euro, Sterling Blindfolded And Up Against The Wall

The Euro and the Pound retreated from their US session highs in overnight trading as the forex market prepares for rate cuts from the European Central Bank and the Bank of England.

The Euro traded lower in the overnight session, settling in a choppy 50-pip range above 1.2840 having touched as high as 1.3115 in New York hours. Sterling followed suit, retreating from highs near 1.62 to rest above the 1.58 mark.

The UK economy shrank -0.5% in the third quarter according to NIESR, a London think tank, meaning the economy has likely officially (unofficially we all know we are in one) sunk into recession. Citing the poor result and the “intensifying banking crisis”, NIESR’s chief economist Martin Weale called on the Bank of England to cut interest rates by half of a percentage point at today’s meeting. Mervyn King and company may yet one-up demands for monetary easing, with overnight index swaps pricing in a 75 basis point cut when policy is announced at 12:00 GMT.

Some analysts are calling for even more decisive action and asking for a cut of one full percentage point. A one percentage point reduction would be the biggest rate cut in 15 years, and comes amid growing anger that banks are not passing on improved terms to lenders.

The Bank has not made such a large cut since it was made independent in 1997; the last time it sanctioned a one percentage point reduction was during the early-1990s slump that followed Black Wednesday.

The ECB, staring at the first euro zone-wide recession since its inception in 1999, is seen certain to cut its benchmark rate by half a point to 3.25 percent, its lowest in two years. But interest rate traders are pricing in a 75 basis point cut.

A half-point reduction would match the October 8 emergency cut made in unison with the Fed and other major central banks. A larger reduction would be the ECB's biggest ever.