13 December 2023

GBP

It has been a light data calendar for the UK over the past week, with only low-impact economic data released, and markets having to live off the odd scrap of political news, such as reported progress on the Northern Ireland protocol between the UK and the Euro area. The pound has therefore been impacted by events elsewhere, with GBP/USD riding on the tails of a stronger EUR/USD for the most part, and pushing as high as 1.2242 yesterday afternoon, after having failed to break over 1.2200 for much of the week beforehand. However, much the same as elsewhere, the failure for risk assets to maintain gains, ensured that GBP/USD drifted back to the 1.2150 region again by the European close, before retesting the highs above 1.2240 in the latest New York session.

The next few days will be key for the UK and the pound, beginning with some good news after the latest growth figures saw UK growth unexpectedly expanding during November at 0.1%, having been expected to decline by around 0.2%. Industrial production declined by 0.2% (MoM/Nov), slightly beating estimates of a 0.3% decline, however, Manufacturing Production declined by another 0.5% over the same period.

Next week is even more significant for the UK, with the latest inflation report, as well as key Employment and Retail Sales data scheduled for release. Inflation will probably just edge employment, and given the recent trend of softer inflation, it is hoped that improvement is replicated in the UK, which would be a boost for everyone including the BoE, who would welcome any softening, given their dire predictions for the UK economy over the next year and a half.

As for the outlook for the pound, the recent trend of a stronger GBP/USD and weaker GBP/EUR could still persist for a while, of course notwithstanding any major shocks from incoming data.

Thoughts from the dealing desk

-Jon Camenzuli, Corporate Dealer

EUR

The single currency has been on a roll recently, culminating with EUR/USD bursting back over 1.0865 for the first time since April yesterday, and GBP/EUR being pushed below 1.1250, despite GBP/USD holding fairly firm throughout the period (see GBP). The moves have been aided by clear evidence of softer inflation for the region, especially amongst key economies, coupled with sharp declines in energy prices and helped in part by a much more mild than usual winter (so far). This has clearly helped reduce much of the financial burden that countries such as Germany had previously committed to, in assisting with energy bills for beleaguered customers with the energy prices bill.

It is not just about energy, however, with broader economic data largely beating estimates within the block, even if those improvements have been from a particularly low base. The ECB has continued with its ongoing hawkish narrative, which is also helping to underpin the single currency. Just this week, several ECB members maintained the 50bps hikes ahead themes, even if one of those was Robert Holzmann, who has been bullish on rates for some time. Of course, the broadly weaker buck also plays a part in helping to drive EUR/USD higher.

However, the camp for avoiding a recession in the region is growing bigger by the day, and this will help to give the ECB further confidence to raise rates further, even if inflation is already moving in a southerly direction. On that note, markets currently expect a whopping 140bps worth of hikes from the ECB through this year, which is one big fat reason why the Euro has looked so attractive, especially when you balance that against a Fed that is rapidly approaching the end of the current hiking cycle. Onwards and upwards, as they say.

USD

Thankfully, for the third month in succession, US inflation has softened, with headline inflation dropping to 6.5% (YoY) from 7.1%, and core inflation dropping from 6% (YoY) to 5.7%. The latest data also confirmed that inflation has now fallen to its lowest level in more than a year, in a clear indication that price pressures have now peaked. Whilst inflation might still remain light years away from the Fed’s 2% target level, headline inflation has now dropped from over 9% in June to current levels. Will the Fed drop that 2% inflation target at some point?

Markets were quick to re-evaluate ongoing Fed rate hikes, with a 25bps move now almost 90% assured for the next FOMC meeting according to market-implied probability, and the odds of a cut in the middle of the year increasing, as markets focus on the speed of decline, anticipating a potentially even faster reduction in the level of inflation from here, even if the Fed remains adamant that they will continue to hike rates beyond next month’s likely 25bps move, for the time being at least.

Amongst the data, and by far the biggest contributor to the softer headline was gas prices, which slipped by almost 10% during December. The news was well received by markets, with risk assets probing higher on the session. However, with markets also rallying strongly in the days leading into the report, and inflation ‘only’ matching prior analyst estimates, there was an element of profit-taking, which somewhat mitigated the short-term upside for equity indexes. As for the dollar, well the news helped to drive the dollar index (DXY) below 102.00 for a spell for the first time since June. USD/JPY also moved under 130.00, aided in part by rumours circulating from Japan that the BoJ is likely to make changes to monetary policy as early as next week, given accelerating Japanese inflation, with Tokyo inflation recently rising to 4% (YoY) during December.

Looking into next week, the latest Retail Sales data from the key December month will be released, which will give us bigger clues as to the mood of US consumers, and will be closely monitored by markets.

AUD & NZD

The latest Australian inflation report surprised many in markets, after unexpectedly rising from 6.9% to 7.3% (YoY/Nov). Driving inflation higher were big jumps in holiday costs and the recent flooding helped to put pressure on food prices over the period, especially root vegetables. However, the latest Retail Sales also surged, jumping by 1.4% through November and well ahead of estimates of 0.6%. There was also a worthy revision for October’s report, jumping by 0.4%, having previously been reported as a 0.2% gain. The much-followed Trade Balance increased to 13,201M, from 12,743M, comfortably exceeding estimates.

With ongoing resilience in inflation, expectations are high that the RBA will hike rates by another 0.25% in their next meeting at the beginning of Feb, with the latest market-implied pricing expecting the terminal (or final) rate to reach around 4%, from the current 3.1%.

Next week’s highlight is the latest Australian employment report. Both AUD/USD and NZD/USD continue to make steady progress higher with AUD/USD within a whisker of breaking back over 0.7000 for the first time since last August. NZD/USD also moved back over 0.6400 for a spell, having briefly moved under 0.6200 just last week.