BoE meeting expected to kick off QE3 with an additional 50 billion in asset purchases

Tomorrow’s BoE meeting is widely expected to kick off QE3 with an additional £50 billion in asset purchases, bringing the total to £325 billion. Market consensus had been reduced from the original £75 billion following improved UK data (10-month highs in services PMI, 7-month highs in services PMI). The decline in 10-year gilts from 2.60% (at the start of QE2) to the current 2.20% as well as the 22% rise in the FTSE-100 since early October has also helped alleviate stress in the markets.

Considering the rapid slowdown in inflation from 5.2% in September to 4.2% in December, as well as the initial negative print in Q4 GDP, the doves at the BoE (led by Adam Posen) are likely to allow the door to open for further easing down the road rather than push for a more aggressive dosage this week. At any rate, the BoE will release its detailed quarterly inflation report next week, in which it will maintain the case for further easing via further downgrading the outlook for growth and inflation.

Favouring EUR/GBP Ahead/After ECB & BoE Meetings 
Sterling may have an upward knee-jerk reaction upon the confirmation of the more modest £50 billion in asset purchases, but this could also imply more purchases as inflation further approaches the BoE’s 2.0% target within less than two years. Meanwhile, the ECB is unlikely to slash its 1% refinancing rate but will announce the second phase of its liquidity-driving LTRO operation, which will further bolster eurozone banks liquidity and raise prospects for more successful sovereign bond auctions. The euro’s recent gains have shown broad technical improvements across the major rates and these are most likely to emerge against the QE3-bound GBP. EURGBP is seen piercing through its 55 DMA of 0.84 (from current 0.8360), towards the 0.8580 cluster resistance (confluence of 200 WMA, 100 WMA and July trendline resistance). Support is seen holding at 0.8230.

Combining EFSF exchange with ECB haircuts
About two months after the ECB was pressured to step up purchases of eurozone bonds to help resolve the eurozone crisis, it is now considering selling some of its Greek bonds as part of the solution. This would enable Greece to meet its €20 billion funding gap required to attain its 120% debt/GDP ratio target by 2020.

The ECB is considering taking haircuts on its holdings of Greek bonds purchased prior to the start of the securities market purchases programme (for investment purposes) and those purchased under the SMP programme (aimed at reducing yields). The selling of Greek bonds purchased under the SMP (about €55 billion) at a price at or near the purchase price (about 70% discount) could produce an estimated gain of €15 billion. Adding these proceeds to those from the sale of pre-SMP bonds would go a long way in closing the €20 billion gap.

The preferred and ‘win-win’ likely scenario (under current discussion) is for the EFSF to purchase Greek bonds from the ECB at a discount and hold them to maturity, preventing every party from taking any losses. This is likely to boost the latest EUR/GBP bounce as long as the medium term rebounding the single currency sustains itself.