We find that financial flows in and out of the UK have a strong impact on sterling, and that since the financial crisis there have been some major changes to flow patterns in several categories. Shifts in net foreign assets held by UK monetary financial institutions are ultimately the most influential, and in the short term it is the outflow of foreign funds from the UK that is most damaging to the pound.

Ever since the Bank of England commenced quantitative easing, investors have feared that the emergence of a buyer in the UK gilt market with unlimited resources could crowd out foreign investors. In addition, the effective debasement of the UK's currency would also render gilts unattractive, similar in the sense that US Treasurys are unattractive right now after the Fed announced its balance sheet operations.

During the boom years, foreign buyers - attracted by high UK yields and a strong currency - entered the gilt market in good size and the majority of holdings appears to have remained in the UK. However, the proportion of foreign holdings has fallen from its peak of 35.9% to 30.2%, largely because gilt issuance has simply picked up so much over the past few quarters.

The dollar was weak during the European morning session, while risk sentiment improved as European stocks climbed. In addition, USDJPY was under pressure after the announcement of the BOJ to leave the benchmark interest rate at 0.1%, and not to intervene directly, even though the BoJ acknowledged that broad quantitative easing is underway. EURUSD's range increased to 1.4971-1.5082 and USDJPY traded 86.17-87.53 in a volatile market.

The NY Fed announced further tests of its facility to conduct reverse repos. Reverse repo has been mentioned previously as one tool that has been discussed as a possible way to drain excess liquidity and remove excess reserves from the system. Subsequent NY Fed headlines state that these upcoming transactions are "prudent planning" and do not "reflect change in monetary policy stance."

Canadian growth returned to the black as Q3 GDP was 0.4% annualized versus consensus 1.0%. But industrial product prices disappointed amid CAD strength.

JPY In the unscheduled policy meeting this morning, the BOJ did not announce an intervention into currency markets. Instead, the main benchmark rate remains unchanged at 0.1%. USDJPY fell sharply after the announcement. However, the BOJ will auction JPY 10tn in 3-months loans at 0.1%, in order to provide liquidity to the struggling economy. The BOJ still acts very cautiously. Government spokesman Hrano announced that Prime Minister Hatoyama and BoJ President Shirakawa are going to meet tomorrow.

At the subsequent press conference, the BoJ acknowledged that this step was quantitative easing in the broad sense, and many government officials expressed satisfaction with the BoJ's step, though denying that a specific request was demanded. The BoJ warned though that previous experience showed the impact quantitative easing on the economy was limited, and warned against excessive BoJ purchases of JGBs as the central bank should not underwrite government debt. It is clear that the BoJ and government are not seeing eye-to-eye on the issue but the government is forcing its hand in light of weak economic prospects in the country.

Prime Minister Hatoyama announced that the BoJ took steps in order to stem deflation. He is pleased with the decision to provide additional lending facilities. BoJ President Shirakawa emphasized that no new steps to monetize JGBs are planned. Liquidity steps were taken to prevent a shortage of liquidity.

Strategy Minister Kan says QE could prevent deflation from deepening and said he was hopeful that the BoJ will live up to government expectations. Finance Minister Fujii said he thinks QE could have positive impact, but that it would be improper for him to ask the BoJ directly to start QE. Banking Min Kamei said BoJ must not just play lip service to on deflation, but must actually take concrete steps to tackle it.

The RBA hiked the Cash Rate Target by 25 bp to 3.75%. After rising momentarily, the AUD quickly fell, and has remained under pressure since the announcement.

The accompanying statement was quite balanced and offered little guidance on future rate hikes. Some may have interpreted this as dovish but our economists note that post-rate-hike press releases are often more about justifying why rates were hiked, rather than providing insight into the future, and that it's not unusual for the tone through a tightening phase to become less hawkish as the RBA moves the cash rate progressively closer to neutral.

The statement again referred to the rise in AUD noting that it will have "some impact in containing prices for traded goods and services in the period ahead, and will dampen growth in the trade-exposed sector of the economy".

Source: UBS, Bloomberg

Tags: GBP