24 March 2023

GBP

The Bank of England (BoE) raised UK interest rates by another 25bps to 4.25% yesterday, marking the 11^th consecutive rate increase from the bank, albeit at a reduced pace this month, in a process which began at the end of 2021. The move came despite the recent banking turmoil and market jitters, following the likes of the ECB and Fed. Seven of the nine MPC members voted for the hike, with the remaining two favouring a pause given circumstances.

In their accompanying statement, the BoE suggested that UK banks were resilient and were well placed to continue supporting the UK economy, including a period of higher interest rates. It is fair to say that (so far) this has been the case.

Of course, markets had already settled on a 25bps hike given the unexpected surge in UK inflation, with the latest data being released a couple of days beforehand, however, the BoE suggested that CPI is still expected to fall ‘significantly’ by the summer, and perhaps to a lower amount than predicted in the previous month, which could help the BoE reach their terminal rate sooner than had been expected. It therefore looks as though this month’s increase (in inflation) could be a one-off. We live in hope.

On the economy, the BoE were ‘more hopeful’, suggesting that growth is expected to remain in positive territory, even during Q2, which had previously been forecast to decline. The next GDP report is released this time next week.

For the most part, the pound continues to strengthen across the board. GBP/USD has now risen from a Jay Powell-induced low of 1.1800 on the 8^th March, to over 1.2300 earlier yesterday. 1.2500 remains the key topside point for sterling bulls to be drawn to. GBP/EUR did start the week in fine fettle, moving back over 1.1400, but the super-strong single currency came roaring back later in the week, which sent GBP/EUR back under 1.1300 for a spell. However, the likes of GBP/CAD continue to gyrate towards multi-month tops, highlighting broader underlying strength for the pound.

Thoughts from the dealing desk

This commentary does not constitute financial advice

-Jon Camenzuli, Corporate Dealer

EUR

Markets can be a bit like Dory from Finding Nemo some days, forgetting what happed previously and needing an almost constant reminder that everything is o.k. The past two weeks could be a good example of this it seems. ECB Head Christine Lagarde really gets this, and has been constantly visible over the past week, doubling down on the ECB’s commitment to fighting inflation, suggesting that there was ‘no tradeoff’ between fighting inflation and supporting stability in the banking system. Whilst Lagarde reiterated that future rate hikes will be data dependent, she made no excuses for the ECB’s commitment to tackle inflation and did not mix her words. It felt like her Draghi moment.

Having raised rates by 50bps to 3.5% last week, the strong messaging from the ECB has helped to fuel market-implied expectations for further rate hikes, especially given the unexpected increases amongst regional inflation of late. On that note, both Spain and Germany will be releasing their latest inflation reports through next week, with the former expected to decline, but key German inflation has been forecast to increase over the past month. Regional inflation is also released a little later in the week.

The single currency has had a week to remember. Buoyed by the hawkish comments from Lagarde, and further fuelled by a weakening dollar, EUR/USD surged beyond 1.0900, having been as low as 1.0516 on the 15^th March. With the Fed looking as though they are nearly at their terminal rate (see USD), further upside gains could still be achieved, as expected rate differentials fuel the single currency.

USD

This week’s Fed meeting was probably the most anticipated meeting for some time, given the recent events amongst US regional banks, and the impact to broader risk appetite. Markets had spent the previous week rapidly repricing future rate hike expectations, with a series of rate cuts now priced into markets, based on the theory that prevailing tighter credit conditions would be expected to slow the US economy, mitigating the need for further hikes from the Fed. Although Chair Powell had suggested (just before the crisis broke) that the FOMC may be inclined to accelerate the pace of rate hikes back to 50bps, markets had settled on a 25 bps move, taking everything into consideration.

In the end, the Fed delivered to script with a 25bps move. The key change in their accompanying statement was the removal of the line relating to ‘ongoing increases’ in rates. The key revised projections saw the FOMC dampen future rate hikes expectations, even if only at the margin. However, the committee have now started to price in cuts through 2024. As we said in yesterday's daily, markets think that those hikes will be forthcoming later this year, with ongoing data likely to be the driver of change, assuming that we get no further bumps along the way.

Jay Powell also did his bit to calm investor sentiment, issuing a statement at the beginning of his press conference, highlighting that all depositors’ funds are safe, and reiterating that the problems were contained within a small number of regional banks. Powell also highlighted that the FOMC did consider a pause in rate hikes in the days leading up to the committee meeting, ultimately deciding against it. It is easy to see the challenge for all central banks over the past week, pause hiking against surging inflation, and markets might just go all Dory again (see EUR), worrying about whether Powell & Co know more than they are telling us. In the end, it made sense to go with expectation. Risk assets have settled, and most were driving higher by the next day. Job done.

However, the Fed are most certainly driving towards the end of their hiking cycle, and the relative difference in rate outlook between the Fed and the likes of the ECB will be a big driver to currency moves going forward. This can clearly be witnessed through the dollar index (DXY), which declined to a four week low earlier in the week, and could be on the way back to 100.00, which is more or less where it stopped in the last run down at the end of January.

Assuming that markets get the opportunity to focus once more on incoming economic data next week, the latest US growth data (Q4) will be a highlight, even if it might be a bit backward looking, given recent events.

CAD

The latest inflation report saw Canadian inflation fall to its lowest level in 13 months, with annual headline inflation dropping to 5.2% through February, having previously been at 5.9%. Markets had been expecting a drop to around 5.4%. Core inflation saw a 4.8% yearly rise, down from 4.9% during January.

Having paused interest rate hikes after reaching 4.5% in February, the BoC look like being on the money, given the snappy drop in inflation. Today’s Retail Sales data might not give markets further evidence of the slowdown, however, as it is expected to have increased by around 0.7%, although back in January, which would be an increase from 0.5% previously.

With USD/CAD having risen as high as 1.3860 two weeks ago, the Loonie has clawed back some of its losses, with the pair moving back towards 1.3600 at one point earlier in the week. That is impressive given that Oil prices have continued to trend lower on a weaker demand outlook and is perhaps a measure of the broadly weakening greenback. With the Fed likely to impact the greenback’s trajectory, and the BoC on a pause, further range trading looks the order of the day for the time being.  

AUD & NZD

Having raised Australian interest rates by 0.25% to 3.6% at their last meeting, the RBA gave the biggest clues yet that they may be readying for a pause in their hiking cycle, amongst the minutes of that last meeting. The Board acknowledged that monetary policy was in ‘restrictive territory’ and given the uncertainty of the economic outlook, it would become necessary to hold interest rates steady for some time, as they assess the impact of their cumulative rate hikes. Sensible words indeed.

AUD/USD has been gradually trending higher over the past two weeks, and having moved briefly under 0.6600, the pair has now rallied back over 0.6715. Much the same as the Loonie, were the RBA to pause their hiking cycle, then further rallies might only manifest from a broadly weaker greenback. The Kiwi has fared slightly better, which itself might be a measure of future rate hikes expectations, with NZD/USD rising from under 0.6100, to around 0.6300.  

Next week looks to be a key week for Australia, with the latest inflation and Retail Sales data due, with both likely to have an impact on the RBA’s decision-making at their next meeting.