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European Central Bank, Bank of England Hold Firm on Policy

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Central banks in Europe stood firm on policy Thursday following rate cuts at previous meetings. Both the European Central Bank and the Bank of England kept rates firm and neither decided to launch any new non-traditional policies. The Bank of England kept rates on hold and kept its quantitative easing program at 375 billion pounds and the European Central Bank did not launch any new bond purchasing programs, as expected.

The Thursday Bank of England meeting followed rate cuts and a quantitative easing program increase at the previous meeting. The sit-and-wait policy from the BoE comes after weak economic data was released in the U.K. over the past several days. U.K. GDP in the second quarter was reported much weaker than expected and U.K. manufacturing PMI's fell well below expectations in July, showing that the U.K. economy continues to slip deeper into recession, despite efforts from Governor Mervyn King at the BoE.

ECB President Mario Draghi did not announce any new bond purchase programs Thursday, as many expected. However, he did mention that bond markets, with high yields and excess risk premiums, do not reflect reality. Also, he stated that the ECB will do whatever is necessary to support bond markets within the Bank's mandate. The ECB may need to find a way to stabilize bond markets without printing money, or else risk angering conservative German economists at the Bundesbank who have spoken against quantitative easing. Draghi hinted that the bank will, over the next few days, discuss further easing measures to come up with a scheme to purchase bonds that appeases all sides.

Markets seemingly did a lap on the headlines. Equities and bonds initially rallied after hearing Draghi was concerned with high yields on peripheral debt, then retreated on unfound hopes of stabilization policies. The EUR/USD spiked as high as 1.2406 on EBS before retreating as low as 1.2264, a huge reversal. U.S. equity futures followed a similar pattern, spiking higher and then retreating to session lows.

Sovereign bond yields traded to session lows, indicating that sovereign bond market participants may anticipate bond market stabilization policies coming imminently. Draghi did note that any purchases would focus on the short end of the curve, with only small amounts of purchases occurring on the long end of the curve. However, yields since re-traced their declines, as Spanish 10-year bond yields spiked to 6.71 percent after falling as low as 6.613 percent. Spanish 2-year bond yields followed a similar pattern and so did Italian bonds.

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