23 December 2022

GBP

It has been an eventful year for the pound, with GBP/USD falling to a record low at 1.0324 for a microsecond in September, as markets reacted with dismay to those now-famous unfunded tax cuts and spending increases that ultimately put paid to Liz Truss and her fledgling government. The reaction since has been mightily impressive, with GBP/USD climbing all of the way back to record a recent top at over 1.2400, and GBP/EUR pushing over 1.1700. The moves have been all the more remarkable, given that during this time the UK economic outlook has deteriorated further, with growth flagging, public sector borrowing rising rapidly, and the overall cost-of-living surging as inflation accelerated beyond 10%.

The Bank of England (BoE) have reacted to surging inflation by raising UK interest rates up to 3.5% just last week. However, the outlook for UK rates into next year looks far more uncertain, which may have been reflected by the split voting decision amongst MPC members. Whilst inflation may have thankfully turned south of late, the road back to the BoE’s target level of 2% looks a long one, but when balanced against a rapidly weakening economy, further hikes are likely to be shallower and less regular.

As for the pound, we need to judge its prospects against both the USD and then the rest. Once US economic activity slows and the Fed stop raising their outlook for the terminal rate (see USD), a more broader dollar decline may ensue, and GBP/USD could be dragged higher, irrespective of the prospects for the UK. Whereas, GBP/anything else is likely to be far more impacted by the ongoing developments in the UK economy. However, recent weak UK economic data has helped to ensure that sterling is limping towards year-end, even if it is a long, long way away from those dark days back in September.  

EUR

Will 2023 be the year for a higher Euro? The single currency has certainly finished this year in fine fettle, with EUR/USD rebounding from a 0.9535 low, to over 1.0700, and GBP/EUR being pushed back below 1.1400. This time last year, ECB Head Christine Lagarde was confidently telling us all that the ECB were not going to be raising Euro area rates this year. In fairness, inflation was only ever going to be transitory (sorry Jay), and the speed that inflation then accelerated quickly caught all central bankers off-guard. The speed at which the ECB moved to hike rates has been a factor contributing to the recent rally for the single currency. Lagarde has been no laggard.

Even though the ECB matched the Fed, BoE & SNB with a 50bps rate hike last week, the accompanying commentary from the ECB was particularly hawkish, suggesting that further hikes will be very much the name of the game as we move into 2023, even though some softening amongst inflation has materialised of late. Indeed, recent comments from the likes of the ECB’s de Guindos, have suggested that markets should expect to see 50bps rate hikes continuing for ‘a period of time.’ Broader economic data has also improved of late, especially in Germany, which should help to make those decisions to hike for the ECB slightly more palatable, for now at least.

As for the Euro, well EUR/USD looks to be at the mercy of the greenback, and thus the single currency is only likely to accelerate once the Fed signal an end to tightening, with the pace of any appreciation in EUR/USD then determined by whether the ECB remain hiking after the Fed for a spell.  

USD

It has been a mixed year for the dollar. Having started a rally back in the middle of 2021, with the broad dollar index (DXY) at around 90.00, the DXY subsequently surged all of the way to 114.70 by the middle of September, before a rapid decline ensued, driving the greenback all of the way down to 103.07.

There were two main drivers to the dollar rally through this year. By far the biggest has been the Fed out-hiking every other major central bank, but a broad ‘risk-off’ market then helped to further cement those dollar gains. Whilst other central banks have since been playing catch-up with the Fed to a degree over the second half of this year, the uncertain outlook for the US economy may give rise to an unpredictable dollar in the early part of next year.

Indeed, recent data has been mixed, which only helps to muddy the waters. The last two reports have seen US inflation soften by enough to encourage the Fed to reduce the pace of rate hikes from 75bps to 50bps. Ongoing weakness in the housing market can also perhaps be expected given the surge in borrowing costs, with long-term fixed rates gyrating around 6%, having been below 1% this time last year. That has been some move. However, the labor market remains particularly robust and sentiment surveys suggest that the consumer is still optimistic for now. The latest growth figures, released yesterday at 3.2% (Q3), also suggest that overall activity remains strong.

The Fed have been doing their bit, recently raising their outlook for the terminal (or final) rate to beyond 5% - US rates are now at 4.25% - 4.5%, whilst also predicting anaemic growth through next year. At present, markets seem unconvinced that US rates will move beyond 5%, but if the majority of data continues to beat expectations, then further sell-offs in risk assets from a frustrated market could ensue. That could help to support the dollar, at least in the short-run.

CAD

It has been a busy week for key Canadian data, with the latest Retail Sales and Inflation reports released. Retail Sales jumped by 1.4% during October, which slightly missed estimates of a 1.5% gain. The recent and familiar global trend of softer energy prices, offset by rising food costs, was also replicated in Canada. Similarly, inflation also played to the emerging global trend, with headline inflation softening to 6.8% (YoY/Nov) from 6.9%, and core inflation remaining stickier at 5.8%, which is perhaps no surprise given those lofty food and beverage price increases.

At their most recent (50bps) rate hike, the BoC signalled that their tightening campaign may be coming to an end, having raised Canadian rates by a whopping 400bps over the past nine months. Saying that, BoC governor Tiff Macklem remains committed to reducing inflation back to the 2% target range, which may still require further hikes into next year to be achieved.

As for the Loonie, well it has been a volatile year at times. With energy prices thankfully turning south over the past few months, the Loonie has been pulled in both directions. USD/CAD would therefore likely be lower, much the same as the recent moves for the greenback against other major currencies, however, if oil prices continue to decline further, any upside (lower USD/CAD) for the Loonie is contained to a degree, and thus USD/CAD has recently been dancing around the 1.3600 handle looking for defining inspiration.

AUD & NZD

The RBA considered pausing rate hikes at their most recent meeting in December. They cited the lagged effects of their cumulative tightening delivered so far, as well as the benefits of moving more cautiously in an ‘uncertain environment.’ The RBA have raised rates by a total of 300bps throughout this year, as they attempted to tackle surging inflation in Australia – which has recently turned south to 6.9%, having topped-out at 7.3% in the previous month. Looking ahead, the RBA still think that they will need to raise rates further into next year, however, the pace and regularity are likely to be far more diminished than previously.

As for the Aussie, well AUD/USD has rallied strongly over the past two months, after reaching a cycle low of 0.6170 at the beginning of October. Looking ahead, the Australian and New Zealand economies are both set to benefit from China’s sudden change of Covid policy, although the recent rapid increases in cases, may delay the benefits for a spell. This could help to broadly underpin both the Aussie and kiwi into 2023.

The team at Moneycorp hope that you have enjoyed our updates throughout the year, and we will be back with our next weekly update on the 6th January. Happy holidays!