Buying the pot

The metaphor would be neater if the European Central Bank were to be in Paris rather than Frankfurt, but today will be a tale of two cities. The Bank of England is expected to double its Bank Rate to 0.5% while the ECB holds its MRO (main refinancing operations) rate at 0% for a 71st month.

Recent price action implies that a 25-basis-point rise from the BoE is now fully priced into the GBP, together with a less specific expectation that more increases will come in following months. The most aggressive plot has Bank Rate at 1.5% by the end of the year.

UK economic data tend mostly to support the argument for higher interest rates. Headline inflation was seen most recently at 5.4%. Unemployment at 4.1% is not far from its lowest level since the 1970s. House prices are pushing upwards, with Nationwide reporting this week that they are 11.2% higher on the year. As a consequence, the GBP has strengthened by an average of 1.1% over the last month, beaten only by the safe-haven JPY. It has added half a US cent and almost one euro cent, despite the surreal state of affairs at the heart of government.

Standing pat

By contrast, it is next to impossible to imagine the European Central Bank taking rates higher today. The unchanging rhetoric from Frankfurt makes clear that the management believes it does not have the power to tackle underlying global inflationary pressures, such as supply chain bottlenecks and expensive energy.

The economic situation in the Eurozone is not markedly different from Britain; the post-pandemic recovery is moving along and consumer prices are steaming ahead. Headline inflation reached a provisional 5.1% in January, with double-digit readings from the Baltic states. Unemployment fell to 7% in December. The first is a record high, and the second a record low since Eurostat began to compile the data at the end of the last century.

Yet, the ECB’s reaction to those numbers has been strikingly different from that of the BoE (and, for that matter, the US Federal Reserve). In London and Washington, central bankers have acknowledged that they must be seen to be doing something about inflation. Even in Australia, analysts believe the Reserve Bank will, before long, have to concede the need for tighter monetary policy. They see no such concession from the dovish ECB. A poll by Bloomberg suggests no upward move for interest rates in the next 18 months.

North American jobs 

The two central bank monetary policy announcements are clearly today’s most important inputs for the FX market. In a supporting role, the round of services sector purchasing managers’ indices will provide colour. Friday’s highlights will be the North American employment data, including the monthly change in US nonfarm payrolls.

The services PMIs will be less positive than Tuesday’s manufacturing readings, softened by the various Covid restrictions around the world. Early offerings from Australia and Japan showed contraction in January at 46.6 and 47.6 respectively. Britain is expected to come in at 53.3 and the Eurozone at 51.2.

Friday’s US employment data will lack their usual punch, now that the Fed has set out its stall for tightening monetary policy. A relatively modest 150k increase in nonfarm payrolls is pencilled in. Analysts expect to see a monthly loss of 117k jobs in Canada, with unemployment rising from 5.9% to 6.2%.