12 March 2023

GBP

As expected, the Bank of England (BoE) delivered a twelfth successive rate hike yesterday (Thursday), raising UK interest rates by another 25bps to 4.5%. At 7-2, the voting pattern was also the same as last time round, with Swati Dhingra and Silvana Tenreyro once again voting for a pause.

The BoE also significantly revised their short term UK inflation outlook higher, admitting that they had underestimated the strength and stickiness (sorry) of food price rises. The BoE now think that UK inflation will not reach their 2% target until early 2025. They had previously expected inflation to subside to that level within a year.

On a positive note, the BoE now think that the UK economy will avoid a recession, with GDP expected to reach 0.25% throughout this year, and then surging by 0.75% during 2024. Gone are the days when Andrew Bailey was predicting a long drawn out recession in the UK, and whilst growth may not be anything to write home about, growth at any level is something to cheer about.

Given that headline inflation remains in double digits, markets still expect the BoE to be forced into further rate hikes, with those changing rate dynamics one of the key drivers sparking the recent rally to a one-year high in GBP/USD. The expected terminal rate is now at 5%, which would imply another 2 further hikes from the BoE. While the pound may have witnessed some profit taking after the BoE, those implied rate hikes could help to keep the pound elevated in the longer run. In the meantime, GBP/USD dropped from over 1.2600, to just under 1.2500 yesterday afternoon, a move which was aided by broader market risk aversion and profit taking/position squaring after the event.

Looking ahead, next week should confirm another solid UK employment report, with ILO unemployment predicted to remain at (or near) 3.8%.

- Jonathan Camenzuli 

EUR

In an ‘almost unanimous’ decision, the ECB raised all Euro area interest rates by a reduced 25bps yesterday (Thursday), increasing their main refinancing rate (policy rate) to 3.75% in the process. The ECB decided to opt for a smaller hike this time round, given tepid growth in the region of late. Much the same as in the US, the rate hike had been fully priced in by markets. However, markets went into the meeting expecting a hawkish tone from ECB President Lagarde in her post-meeting conference, given persistent Euro area inflation.

With the ECB having raised Euro area rates by another 25bps last week and signalling further hikes to come, one may have assumed that the Euro would continue rising, but the single currency has since struggled to maintain its impressive recent rally, with EUR/USD slipping from a high of just under 1.1100, to around 1.0900 by yesterday (Thursday).

Markets seem unconvinced that the ECB will persist with rate hikes for much longer than the Fed, which may be impacting the short-term profile for the single currency. Recent commentary from ECB officials has also left more questions than answers, with a more cautious view on future rate hikes from the ECB’S Nagel, even if the likes of Lagarde and Kazaks have maintained their own hawkish outlooks.

On the data front, the latest release of German inflation saw Harmonised inflation remaining at 7.6% on an annual basis. Regional inflation is expected to remain close to the 5.6% region when released next week. The latest growth data is released next week too, with provisional regional growth predicted to have risen by 0.1% during the first quarter of this year and 1.3% on an annual basis.

Back to the Euro and overall market risk sentiment will play a big part in dictating the short-term profile for the single currency. If markets remain twitchy, then this will likely feed through to a weaker Euro and vice-versa. 

USD

The latest US inflation report came out just below estimates, with headline inflation slipping under 5% for the first time in two years, dipping to 4.9% on an annual basis during April, and core inflation also dropping to 5.5% over the same period. Markets had been expecting the headline rate to remain above 5%. The news may just give the Fed enough wriggle room to pause rate hikes at their meeting next month. On that note, market-implied expectations for a 25bps hike dropped from over 20% to around 5% in the immediate aftermath, suggesting that markets have convinced themselves of a probable pause. Lower airline prices helped to soften headline inflation.

The subsequent rally in risk assets was somewhat short lived on the day. This is perhaps due to several reasons. On inflation itself, whilst it is pleasing to see further declines, inflation still remains 3% above the Fed’s 2% target level, so the Fed are unlikely to be cutting US rates anytime soon, even if markets disagree and have been pricing in several rate cuts before the end of this year.

There are also several other big issues worrying markets just now. The US debt ceiling negotiations are once again looking like they will go to the wire. Janet Yellen has been pushing for a conclusion, given that she has the brains to work out just how catastrophic it would be if the US defaulted. Talks are ongoing, but the closer we get to the beginning of June, the twitchier markets will get. Donald Trump has advised the Republicans to allow a default. That kind of talk will do little to settle markets in any way. If that were not enough, in spite of talk that all is well, the pressure on regional Banks still persists, with shares in Pacific West coming under intense selling pressure over the past week, as they deal with large deposit outflows.

As for the dollar, well the dollar index (DXY) has remained fairly rangebound over the past week, buoyed at times by broad risk aversion. However, with the Fed pause the most likely scenario, those changing rate dynamics could limit any upside potential for the greenback. Looking ahead, the latest Retail Sales are likely to dominate market attention. 

CAD

Last week’s Canadian employment report saw another month of strong gains as the labor remarket remains impressively robust. The economy added another 41.4K new posts during April, above the March gain of 34.7K, and beating estimates of a 20K increase. Overall unemployment also remained at 5%, beating estimates of 5.1%. That news helped to lift the Loonie to a 5-week high, with USD/CAD dropping to as low as 1.3300 at one point on Friday, having been as high as 1.3630 just last Thursday. The news will give the BoC some slight cause for concern as they battle a broadly weakening economy, against a red-hot Labor market.

Next week should give the BoC more insight into the current state of the Canadian economy, with the latest inflation and Retail Sales data due for release. On the inflation front, the BoC may get some good news, with yearly core inflation expected to moderate further from 4.3 to 3.7% during April. Headline inflation could fall even further, given recent weaker energy prices. That would go some way to justifying the BoC’s decision to remain on pause, even if the labor market remains red-hot.

Back to the Loonie, and after the big jump from 1.3600 to 1.3300 last week, this week has been one of consolidation, culminating in USD/CAD rallying back to 1.3500, with oil prices and broad risk aversion the big drivers behind the reversal. 

AUD & NZD

Recent economic data from Australia has questioned the RBA’s recent decision to resume rate hikes, after their previous short pause. Retail Sales over the first quarter declined by 0.6%, having been expected to have declined by around 0.4% over the period. However, consumer inflation expectations remain robust, rising from 4.65 to 5% in the latest survey. Next week sees the release of the minutes from that surprise RBA meeting, which should give markets a better insight as to the RBA’s next move. The latest Australian employment report is also due, which could see overall unemployment decline to a very respectable 3.3%.

For a while this week, AUD/USD surged to a near three-month high, pushing back over 0.6800. However, that broad market risk aversion helped to reverse the gains, with the pair moving back below 0.6700 by yesterday (Thursday). NZD/USD broadly followed, moving as high as 0.6385 – a one month high, before slipping back below 0.6300.