Dovish hikes and hawkish tones
Another hike from the Bank of England yesterday, this time 0.25% and the 3rd hike in a row, taking UK interest rates up to the dizzy heights of 0.75%. That puts UK rates back to the pre-Covid level now.
Whilst the move to hike by the BoE could be easily explained by persistently high inflation, which is now expected to hit 8% (YoY) by the middle of summer, there was a distinctly dovish tilt to proceedings.
The vote 8-1 was accompanied by a more cautious outlook from the committee in the path for rates over the next year. Although admitting that the UK jobs markets remained robust, the BoE noted that consumer confidence was already on a downward trajectory, and the squeeze on household incomes was set to increase. That all combined to put further pressure on future growth expectations for the UK economy.
Sterling therefore lost its way on the day, with GBP/USD slipping from just over 1.3200 to around 1.3100, before rebounding. It is that rebounding which also stands out from last week’s moves. Currencies, by and large, have found their mojo against the dollar (see USD) this week, and GBP/USD was no exception. Having flirted with a break of 1.3000, a much-improved risk sentiment in markets encouraged the fight back.
For the UK, the focus now turns toward chancellor Rishi Sunak, and his Spring Budget/Statement next week. The Chancellor is likely to focus on the spiralling cost of living for UK households – which will not be helped by those BoE interest rate hikes. Some have been calling for a pause/cancellation to the planned 1.25% increase in national insurance. With government coffers being boosted by the increases in the likes of fuel tax revenues, overall expected borrowing costs have declined sharply. So, perhaps Rishi will ultimately be able to offer some much-needed help in the end.
The single currency remains the markets preferred transmission mechanism for reflecting the ongoing developments in Ukraine, and had fallen victim to a much-publicised rapid decline at the beginning of the war. So, a combination of better news on the peace talk front, a weaker dollar (see below), served to deliver an impressive comeback for EUR/USD through this week. Having reached a low of 1.0800 barely 10 days ago, EUR/USD surged back through 1.1100 yesterday afternoon. Strong work. GBP/EUR fared badly too, and has now slipped back to around 1.1800 – having also been well above 1.2000 just recently, reflecting that comeback and the stuttering pound.
Helping to drive to that narrative has been the ever-increasing inflation in the region. Before Ukraine, markets had moved to price-in 2 rate hikes from the ECB by the end of this year, as inflation continued to accelerate at a dizzy pace.
Those hikes then quickly went out of the window as the war in Ukraine escalated. However, there is every chance that markets will push the rate hike envelope back on the agenda for the ECB if things settle, and inflation expectations override growth concerns again. Madame Lagarde alluded to as much during the last ECB meeting, as she put the ECB’s focus on ending QE, over growth concerns.
The FOMC delivered a 25bps rate hike to markets this week, in a move that was fully priced into proceedings, and the first rate hike for the world’s largest economy since 2008. The big news would have been if the committee had followed the lead of Bullard, and voted for a 50bps hike, but in the end ‘Jimmy’ stood alone. As we said before, the interesting part was always likely to be the revised staff projections, and those ‘dot’ plots suggest that the fed will raise rates as much as 6 times this year, or once a meeting – making every meeting now ‘live’, as Jay likes to call it.
If that is the case, then we could even see U.S rates as high as 1.9% by the year end, and the ‘terminal’ or end of cycle rate might reach 2.8%, which would exceed the ‘neutral’ rate of 2.4%, if achieved. The neutral rate is the projected rate at which an economy neither runs too hot, or too cold. In reality, the economy will always be doing one or the other, but stay with me, as in the land of looking ahead, this all matters apparently.
Talking of which, markets are now themselves starting to question whether Fed will ultimately be able to deliver a hike at every meeting this year, and this is perhaps why there was a positive rebound on the day, with the dollar slipping against its peers. Indeed, there remains many doubts about the outlook for global growth, and the war in Ukraine has exaggerated those fears.
For the dollar, well markets took heart from the ongoing peace talks on Ukraine, and the greenback struggled to maintain its lofty recent highs through the rest of the week. The broader dollar index has now slipped back from a top near 99.50, to 97.75.
Cast your mind back a week, and whilst raising Canadian interest rates, the BoC were telling us all that there was still plenty of capacity in the economy to hike rates again moving forward. Canadian economic data has since continued to deliver to that end, with hotter-than-expected inflation and the latest Home Prices surging by 3.5%.
Today’s Retail Sales should also reflect a 2.4% gain though January, which is another example (should we need it) of the underlying strength of the Canadian economy. Whilst Oil prices have reversed somewhat over the past week, they still keep popping above $100, which is a boost to the Loonie. All told, the BoC will likely still have all the capacity it needs to hike Canadian rates again next month.
The Loonie had a good week too, which is perhaps unsurprising given what I said before. USD/CAD resisted the temptation to break back toward 1.3000, and is now hurtling back to 1.2600 – a 2-week CAD high, a break of which would take the pair to a level not seen since the early trading sessions of the year.
AUD & NZD
Will the RBA hike next? That’s a possibility, if not a probability. Upbeat employment data teased markets, as a 77k in February surpassed expectations by a wide margin again. Overall unemployment dropped to 4%, a level not seen since 2008. Impressive. The head of labor data at the Australian Bureau of Statistics (ABS), said that the gains were ‘remarkable’. However, wage growth still needs to accelerate at a faster pace according to the RBA, and although inflation is doing its bit, the RBA may have enough wiggle room to remain on the fence, for now at least – even if the pressure continues to build for a hike.
AUD/USD rebounded strongly from 0.7175 to probe a potential break of 0.7400. That is not quite at the 0.7450 level seen at the beginning of the month, but within earshot. However, the pair has now moved from under 0.7000 at the beginning of the year to this region, which perhaps reflects in part growing market expectations for the RBA.
In New Zealand, Q4 GDP missed estimates at 3%, versus 3.2% expected. The influential Fonterra Co-operative group said that China’s demand for dairy products remains intact, despite the surging cases of Covid in China. Whilst the situation remains fluid, that news gave the kiwi a positive boost on the day. NZD/USD is still following in a similar path to AUD/USD, and is now probing a break of 0.6900, having been as low as 0.6550 at the end of January.
One to watch... the Swiss Franc
Much the same as the dollar, or perhaps the JPY, the Swiss franc has historically been a beacon of currency comfort, at times of intense market stress. That happened over the past few weeks, and is why I have included the ‘Swissy’ in our one to watch for this week.
Given that USD/CHF, or CHF/JPY contain another safe-haven currency, a glance at where EUR/CHF is gyrating will give us more insight into broader market sentiment. That EUR/CHF chart is one to behold just now. Having moved down from 1.0600 to test and break parity for a spell at the beginning of this month, the pair has now climbed back to 1.0400, reflecting both EUR strength (see EUR) and CHF weakness, and a more positive sentiment.