Weekly Brief

A hawkish ECB

16 December 2022

GBP

The bank of England raised UK rates yesterday by a further 50bps, moving the base rate to a 14-year high of 3.5%. Whilst the 50bps move was completely priced into markets, the 9-member BoE voting pattern was a surprise to markets, given that there appears to be a fairly broad opinion amongst MPC members. Six members voted for the preferred 50bps move, with two opting for no hike and one member thinking that 75bps would be the right choice.

In his post-meeting conference, BoE head Andrew ‘honest’ Bailey said that ‘I know raising interest rates has a real impact on people’s lives, but by raising interest rates we can bring inflation down sooner and help the economy begin to grow and prosper once more.’ The majority of MPC members also suggested that further hikes were likely ‘for a sustainable return of inflation to target.’

The current market-implied terminal (or end) rate from the BoE is at just over 4.5%, a level that has been on the decline of late, as markets re-evaluate the impacts of a weakening UK economy, and (thankfully) softening inflation, albeit at the margin for now.

The pound also declined after the BoE, with GBP/USD slipping from a 6-month high at over 1.2440, back to 1.2200. However, we were at that level just this Monday, so the move may well have been driven partly by position squaring as markets reduce risk and portfolio exposures into the holiday season. Next week is dominated by the latest growth figures, with Q3 GDP expected to have declined by 0.2%, as the UK slips into a recession. Indeed, this week’s data highlighted a slight increase in the overall unemployment rate from 3.6 to 3.7% combined with an unexpected jump in the claimant count of 3.5K. With average private sector earnings also increasing sharply, there is a lingering fear that companies will pass on higher wage costs through price increases, which could keep unwanted pressures on inflation. Next year therefore looks a tough one on paper for the UK economy, even if the pound continues to take its lead from broader dollar moves.  

Thoughts from the dealing desk

“Yesterday afternoon’s drop for the Pound has been unexpected and has shown two things in FX markets, (1) even if you guess all the outcomes of central bank meetings and economic data releases correctly, it is still impossible to know which direction the market will go; and (2) never get lulled into a false sense of security. Despite everything being roughly in line with expectations, we have seen a 3% swing in less than 24 hours on GBP/USD, and this seems fairly minor compared to some of the volatility we have seen over the past 12 months. Many clients use a “layered” approach to their FX transactions & hedging, which can smooth out some of these bumps in the road. Please get in touch with your Moneycorp Dealer to discuss if that strategy could work for you.”

-Joe Calnan, Manager – Corporate FX Dealing

 

EUR

The ECB may have replicated the moves of the BoE, Fed and SNB this week, when raising Euro area rates by a further 50bps to 2.5%. However, the accompanying language from ECB Head Lagarde was far more hawkish than that of the Fed or BoE, as Lagarde & Co doubled-down on the ECB’s commitment to continue hiking rates, in order to combat surging inflation in the region. Lagarde stressed that ‘we judge that interest rates will still have to rise significantly and at a steady pace.’ She went on to say that further hikes of 50bps should be coming for ‘a considerable amount of time.’ That last line really caught our attention.

Markets were themselves caught slightly off-guard by the brazen hawkishness of Lagarde, just as much as Lagarde & Co were caught out by the surge in Euro area inflation earlier in the year. However, those who turn-up late to the party are often the last one’s dancing, and the ECB will take our honesty award from the BoE, as they look to continue with their hiking cycle, even though recent data has reflected a slight drop in Euro area inflation. Saying that, both German (11.3%) and Spanish (12.6%) inflation remains sticky, and that may have played a part in the ECB’s rather forceful language yesterday.

The market reaction to the ECB was fairly swift, with yields rising in key Euro area bonds and EUR/USD briefly moving over 1.0700 for the first time since the middle of June. Indeed, the gains for the single currency were fairly broad-based, with GBP/EUR succumbing to Euro strength, and slipping back under 1.1500.

Interestingly enough, the latest Euro area inflation data is due out later today. Next week will be a combination of position-squaring heading into the holiday period, combined with mostly less-sensitive data releases, so expect the single currency to be driven by the broader dollar moves.  

USD

The Fed raised US rates by another 50bps earlier this week, moving their target range to 4.25% and 4.5%, and taking US rates to their highest level for some 15 years. The move also ended the Fed’s cycle of 75bps hikes, which had been widely expected by markets leading into the meeting, given two consecutive months of softer CPI inflation data.

During the post-meeting press conference, Jay Powell reiterated that ‘ongoing increases’ (in the policy rate) would be necessary, as they continue with their battle to return inflation back towards their target range, whatever that might be nowadays. Powell also underlined the Fed’s seeming commitment, by suggesting that ‘historical record’ cautions strongly against premature loosening.

The odd bit was the market reaction, which was fairly muted on the evening. Granted, FOMC meetings in the last few days before the Christmas break often end up being a damp squib, but the immediate reaction seemed as if markets do not firmly believe/take on board what the fed are saying, and perhaps feel that the trend of recent weakening inflation will accelerate into next year. Indeed, several analysts this week have publicly suggested that inflation may fall just as quickly as it rose. Recent data does not highlight a particularly softer US economy, however, with the Labor market remaining frothy, consumer confidence remaining resolute, and healthy-looking PMI data.

Having failed to bounce on a fairly hawkish Fed, the dollar did manage to rally after both the BoE and ECB meetings on Thursday. Perhaps markets were waiting for the complete picture before making their moves. Therefore, having failed to break below 103.00, the dollar index (DXY) then moved back over 104.00 by the European close yesterday evening. USD/JPY followed behind, rallying back over 137.50.

The latest growth figures are released next week, with Q3 GDP expected to remain at (or near) 2.9%. There is also a batch of housing data due, which should give us further clues as to the ongoing impact of those hefty rate hikes over the year.

CAD

USD/CAD has struggled for direction of late. On the one hand, the recent big drop in oil prices has weighed on the Lonnie, which has ensured that USD/CAD has remained close to 1.3700. However, the broader trend of greenback weakness has been a hard pull on the other side, mitigating those Loonie declines (rallies in USD/CAD) on a regular basis. A breakout looks on the cards, and next week could be the week, with the latest Canadian inflation report due for release. Core inflation is expected to have risen from 5.8% (YoY) to 6.4%, which if true, will heap pressure on the BoC to continue raising Canadian rates.

Further evidence on the current state of the Canadian economy comes in the shape of the latest Retail Sales figures, which may improve after last month’s surprising 0.5% decline. Finishing the week off is the latest growth report, which just happens to be one of the last keynote data releases before the Christmas break.

In their latest update, the IMF think that Canada is still well-positioned for growth, although the economy is at risk of a ‘mild recession’, however, they favour Canada to be one of the better performing countries amongst G7 throughout next year. They are somewhat cautious around the Canadian housing market, with a potential decline of around 20% from the high.

AUD & NZD

There was a big surge in Australian employment, after the latest data this week reflected headline gains of 64k through November, beating analyst estimates of 43K. interestingly enough, full-time gains outstripped part-time gains by a fair whack, suggesting that those gains are stickier in nature. The overall unemployment rate remained steady at a healthy 3.4%, with total participation increasing to nearly 67%. Pretty impressive.

AUD/USD took a bad tumble through yesterday, however, with weak Chinese data and the stronger greenback giving the Aussie a double downside delivery on the day. In China, soft Retail Sales and Industrial Production through November were the main culprits, as AUD/USD slipped from a high approaching 0.6900, all the way down to under 0.6700, reflecting a whopping 2.5% decline for the pair, which may not sound much, but is big in terms of daily outright currency moves excluding the likes of emerging market currencies. Next week is dominated by the latest RBA minutes.

New Zealand data was dominated by the latest growth figures, with a better than expected 2% gain though Q3. That put year over year growth at 6.4%, and way ahead of expected gains around the 5.5% region. NZD/USD followed the Aussie yesterday, and slipped back below 0.6330, having been over 0.6500 earlier in the week. Although there is no keynote data scheduled for New Zealand next week, both the Aussie and Kiwi will be on high alert for the latest PboC rate decision.

 

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