How Markets React to the Bank of England Bond-Buying Deadline? | Daily Market Analysis

Key events:

• US - Core CPI (MoM) (Sep)
• US - CPI (YoY) (Sep)
• US - CPI (MoM) (Sep)
• US - Initial Jobless Claims
• US - Crude Oil Inventories

The dollar weakened yesterday amid uncertainty over the Bank of England's willingness to continue supporting the country's bond market, which has become a key pressure point for the global financial sector.

The dollar index, which tracks its exchange rate against a basket of six developed-country currencies, fell 0.1% to 113.15 as some traders bet that the Bank of England will be forced to extend its direct bond purchases beyond its own Friday deadline.

On Tuesday, Bank of England Governor Andrew Bailey said with unusual candor that pension funds have 3 days to sort out their current positions, causing the pound to plummet. However, he recovered most of his losses after the Financial Times reported that Bank officials had privately informed bankers that they might be extending the deadline after all.

The confusion brought GBP/USD to $1.1021, up half a percent from Tuesday night in the U.S., but the market is waiting for more clarity.

Data showing that the U.K. economy contracted in August hardly lifted sentiment, with production, services, and construction figures for the month coming in worse than expected.

"What we're seeing in real-time in the U.K. is a decades-long hyper-financing of the economy that is partly unfolding at gunpoint; and/or a trigger for a decades-long hyper-banking of the market at speed; or both," Michael Avery, global macro strategist at Rabobank, said in a note to clients. He warned that "if you broaden the overview, you can get even more."

Simon French, a chief economist at Panmure Gordon, wrote on Twitter that Bailey's comments were essentially nothing more than a repeat of the Bank's press release issued a day earlier. It talked about a shift from direct bond purchases to lending operations that have a more manageable impact on the money supply and, therefore, on inflation.

EUR/USD struggled to advance, rising 0.1% to $0.9712 after Bank of France Governor Francois Villeroy de Galhau left doubts about the European Central Bank's ability to keep pace with the pace of interest rate increases.

Villeroy said it was too early to tell whether the ECB should raise its key rate by 50 or 75 basis points at its Oct. 27 meeting, a week before the next Federal Reserve meeting. Villeroy also said that the bank's refinancing rate should be at a neutral level or "slightly less than 2 percent" by the end of the year, allowing the ECB to reduce its balance sheet.

Also, the day before, the Korean won strengthened after the Bank of Korea raised its key rate by 50 basis points to 3.0%, as expected, and warned of an impending rate hike. Bank representatives explicitly pointed out that the weakening of the won was one of the factors contributing to the inflation target being exceeded.