Weekly Brief

A jumbo rate hike from the ECB

09 September 2022

GBP

In what’s been a difficult start for the new Prime Minister’s first week in office, Liz Truss has announced her plans to help the UK with the crippling energy price increases. As had been expected, the ‘typical’ household energy bill is to be capped at £2,500, having previously been scheduled to increase to around £3,549 per year from next month. The government will swallow the difference, with Truss also announcing that there would be no funding for the scheme coming from any private sector windfall taxes. Truss highlighted instead that the UK needs energy companies to invest in projects in the UK to ensure that we do not get crippled by the wholesale spot price of natural gas in the long-run again. Businesses will get the same treatment, although their assistance is for six months, and then a separate scheme will be introduced.

As part of the longer-term solution, there will be new licenses granted for North Sea exploration projects, nuclear and renewable energy schemes, as well as expanding storage facilities. Whilst it is impossible to identify the true cost of this mammoth scheme, given that that will be dependent on how much actual energy is consumed this winter and beyond, some analysts are suggesting that it will extend the government’s borrowing costs by somewhere between £100 to £150bn over the period. The scheme is expected to last for two years, which brings us up to the next general election.

Whilst there had been fears that any government energy schemes will add to inflation in the UK, analysts have now been suggesting that we could actually see inflation decline from these levels, with that move boosted by the energy price cap. On that note, the BoE are fully expected to raise UK rates again next week, with chief economist, Huw Pill, alluding to such when asked by the House of Commons Treasury select committee the day before.

As for the pound, well GBP/USD finally succumbed to the dollar, and slipped to levels not seen since 1985, down at 1.1405. However, the move was short-lived, and the pair had moved back over 1.1500 by the next day. Whilst GBP/USD remains vulnerable to broader dollar moves, the BoE meeting next week will also impact the short-term profile for the pound, as well as the latest CPI reading, which moved above 10% last month for the first time in this cycle.  

EUR

Pressure from within the ECB from the likes of Austrian central bank governor, Robert Holzmann, who had been campaigning for a more aggressive level of rates hikes to fight surging inflation, finally took its toll, as the ECB raised Euro area interest rates by 75bps yesterday. In their accompanying statement, the ECB said that further hikes were on the table over the next several meetings. Christine Lagarde said that extended rate hikes could persist for the next two to five meetings, and that the level of hikes may not decline all of the way out to the terminal rate, whatever that may be.

Whilst the ECB may be indicating that there is a long way to go on hikes, markets are far more cautious given the weak economic backdrop that is prevalent in Europe. There is still every likelihood that the ECB may be forced to pause their pace of rate hikes in the early months of next year, were a recession to become obvious. It is perhaps this thought that weighs so heavily on markets, and maybe one of the main reasons why EUR/USD was unable to benefit positively from the 75bps hike on the day, slipping back from just over parity, to around 0.9950. Increasing bond yields did not help the single currencies cause either. GBP/EUR had also briefly popped its head under 1.1500 for the first time in this cycle, but rebounded alongside all of the major currencies against the single currency on the day.

Looking ahead into next week, we get the latest inflation updates from Germany and the rest of the region. Any sign of weakening will be greatly received, and given that energy prices have moved lower over the period, we could actually see a slight improvement, which could well boost the single currency, at least in the short-run.

USD

We are now just two weeks away from the next FOMC meeting, and US data since the last meeting (back in August), would suggest that another 75bps hike is a given by the Fed. As well as solid labor data, the latest ISM Services PMI data this week highlighted another pop higher in the services sector, triggered by increases business activity, with supply chain and logistics reflecting ongoing improvements.

Whilst next week’s inflation and Retail Sales data both matter, with the former the real key, the Fed are unlikely to react to one rogue data print, and therefore even if there is a softer inflation profile, it will not likely sway the Fed’s thinking.

The dollar has continued to shine in this nervous market, with risk assets struggling to make any meaningful upside headway. The dollar index broke over 110.00 for the first time in this cycle earlier in the week, but was unable to sustain the gains. However, that is not the whole story with USD/JPY continuing to rally on those ever-expanding rate differentials between the US and Japan, and with Kuroda and the rest of the BoJ adamant that they are not going to reduce stimulus until Japanese inflation remains at (or above) 3% for around 6 months, the pair was able to break above the previous cycle high, to reach the rather remarkable level of 145.00. Saying that, we could see more bouts of verbal intervention from Japan, which whilst unwelcome on the day for dollar bulls, are highly unlikely to be a successful strategy in the longer-run.

 

CAD

As expected, we got another big hike from the Bank of Canada this week, and after last month’s headline-grabbing bumper 100bps move, we had to settle for 75bps this time round. That has put Canadian rates up at 3.25%, moving above the 3% threshold for the first time since way back in 2008.

Looking ahead, the BoC highlighted that further rate hikes will be likely saying; ‘given the outlook for inflation, the Governing Council still judges that the policy interest rate will need to rise further’. Furthermore, the BoC highlighted that ‘Quantitative tightening is complementing increases in the policy rate’, which of course is the process of reducing the BoC’s balance sheet over time. The rate increase was the BoC’s fifth this year, and after previously speaking about a potential ‘soft landing’, the BoC omitted such language from their statement this time round.  

Whilst the Canadian economy remains relatively strong versus its peers, with consumption and business investment very strong according to the BoC, the next probable move by the BoC is likely to be 50bps next month (Oct 26), as they continue to decline the size of hikes going forward.

Looking ahead, today’s employment report (August) will be key after last month’s surprising 30.6k drop for the Net Change in Employment. The Unemployment rate is forecast to pop up from 4.9% to 5%. As for the Loonie, well having briefly pierced 1.3200 for the second time in this cycle, USD/CAD spent the rest of the week between 1.3100 and 1.3200, before a sharp decline back to 1.3000 ensued overnight. That was no mean feat for the Loonie, given that the price of oil declined to levels not seen since January, with US crude hitting a low approaching $80pbl yesterday.

AUD & NZD

Whilst being nowhere near as bad as Europe, the UK and US, surging inflation in Australia prompted the RBA to hike rates for a fifth month in a row by 50bps to 2.35%, a move which had been widely forecast. Whilst therefore perhaps not surprising, the pace of rate hikes is the fastest for three decades, and lifted the official cash rate to its highest level since 2015. Historically, Australian interest rates have often been much higher than that of most of the developed world, which has made Australian assets attractive for global investors, although the RBA currently sit behind both the Fed and BoC at present, and continue to hike in smaller increments.  

Whilst still forecasting future rate hikes to deal with inflation, the RBA’s statement had a more dovish tilt to it, and that is perhaps no surprise given that Australia’s biggest export market (China) continues to be impacted by large-scale lockdowns, hampering economic growth. The latest export data, released after the RBA on Thursday attested to such, with a near 10% decline over the past month.

As for the Aussie, well the ongoing decline continues, with AUD/USD slipping back to tap 0.6700 earlier in the week, as the long-term decline for the pair from 0.8000, remains the order of the day. The kiwi followed suit, with NZD/USD touching 0.6000, its lowest level for two years or more.

Looking ahead, it is a busy week for both Australia and New Zealand, with the former releasing the latest employment data, and the latter releasing a GDP update.

 

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