Weekly Brief

Interest rate differentials matter


A combination of factors has combined to drive the pound materially lower this week. UK economic data has played a part, with particularly weaker Retail Sales and Consumer Confidence catching the market's attention. Consumer Confidence is now approaching an all-time low. The latest UK government borrowing figures for the past financial year may have also reflected that government borrowing requirements had halved from the previous year, but that previous year was the worst on record. The most recent data showed that March was the worst month for UK government borrowing on record, and the government spent a whopping £70b in debt interest payments alone last year. 

This all brings the BoE into focus. They would love to raise interest rates some more, as early as next week we hear, as they attempt to battle surging inflation in the UK. But with the cost of living skyrocketing, and wage increases unable to keep up to pace, they look to be attempting to walk a very thin tightrope wearing big, fluffy slippers. The fear here is that the BoE could end up raising interest rates into a weakening economy, which never ends well. 

All of this helped to drive the pound lower. In particular GBP/USD, which has failed to hold 1.3000 after refusing to break below with any significance for so long, capitulated and moved back to 1.2400. With interest rates set to surge in the U.S (see USD), and markets walking back from prospective UK rate hikes, this move was perhaps expected, if a little sudden. 


Much the same as the pound, EUR/USD has found the going rather challenging over the past week, and the bulls have, at times, been attempting to catch a falling knife, as the pair slipped through support after support in fairly quick succession. We started the week at 1.1000, and at the time of press, we have now broken below 1.0500. Give the markets a growing interest rate differential, and they will give you currency volatility in abundance. 

Oddly enough, some of the Euro area data hasn’t been too bad this week. The latest German IFO gave a clean sweep of beats across the board, with Business Climate, Current Assessment, and Expectations all-surpassing estimates. However, Consumer Confidence (both German and EU-wide) missed, which one might expect. The growing energy dispute between the EU and Russia is also a factor weighing on the single currency. 

The ECB looks as though they may finally be readying themselves for a July rate hike. Governing Council Member, Martins Kazaks, reiterated his comments of last week and suggested that a hike could come in July. Furthermore, he suggested that the two to three hikes priced in already by markets were reasonable, which will further solidify market expectations. 

However, even if the ECB does raise rates in July, and then again in September, they will still be falling way behind the pace of the Fed, and it is those expected changes in interest rates that are driving the dollar, and the declines of currencies against it. 

GBP/EUR has therefore been caught in the middle of a duel that resembles one perhaps attempting to find the best-looking currency in an ugly competition. The broad range of 1.1800-1.2050 has held for now, and any moves beyond this may take their cue from what the ECB and BoE do or don’t do, over the next few weeks. 


The mighty greenback conquers all then. This week has seen the dollar mark significant gains against pretty much all currencies that we monitor on a regular basis. Markets are fully on-board with a series of 50bps rate hikes over the next three FOMC meetings and have now fully priced this in. It is the pace of those projected Fed rate hikes that is giving the dollar such a strong boost. 

On the data front, only a total collapse is likely to force the Fed to change its heart, and perhaps consider altering the pace at which they hike U.S rates. On that note, we should look at the latest U.S GDP (Q1/Prel) print by way of example. Admittedly, it is a preliminary reading, so it is open to amendments/adjustments going forward. However, the initial reading declined by 1.4%, totally missing estimates of a 1.1% gain. Despite this, markets shrugged it off, and it hardly put a dent into the dollar’s dominance. The greenback declined for all of about five minutes. 

The broader dollar index moved over 103.50 this week, reflecting that strong upside bias we are seeing. USD/JPY broke above a 20-year high, piercing the 130.00 psychological regions, and then continued to push beyond 131.00. That move was enough to stir Japan’s MoF into action. They reacted by saying that they ‘will respond to Foreign Exchange moves if needed’. 

However, as much as a verbal intervention has the power to drive the yen higher in the very short-term, only collective and actual intervention by the key major central banks in unison, might be enough to deter markets in the longer run. That move is unlikely to be forthcoming anytime soon. It is also somewhat laughable to see the MoF attempting to talk the yen higher on one hand, whilst on the other, the BoJ is doubling down on their asset purchases, as they attempt to maintain a 0.25% yield target on 10-year JGBs. 


The Bank of Canada governor, Tiff Macklem, said this week that the BoC is likely to consider another 50bps rate hike, at their scheduled meeting in June. He also said that the BoC is prepared to raise rates ‘forcefully if needed’ to get a hold on inflation, suggesting that the BoC needs to raise interest rates relatively quickly to cool Canada’s overheating economy. 

Despite this, the news did little to impact the path for USD/CAD. Having been as low as 1.2400 just ahead of the recent 50bps rate hike, the pair succumbed to that broader USD strength and quickly rallied to over 1.2800. Look beyond the USD/CAD pair, however, and there is clear evidence of broader CAD strength. GBP/CAD has now slipped from a near 1.7400 level in February, to under 1.6000 this week. EUR/CAD is just as weak, falling from 1.4600 to 1.3400. So, whilst the CAD is not as strong as the USD just now, it is benefitting across a wider basket of currencies, and the projected rate hikes by the BoC could add more fuel to that fire. 


The pull of higher inflation has really been evidenced in Australia this week too, with the latest Consumer Price Index moving above 2% (QoQ/Q1). That represents a 20-year high for Australian inflation, and energy costs were at the front and center of the rise. The news will give the RBA much food for thought, as they convene next week. Market expectations for a rate hike have been pushed out until June, but that expectation has been derived from the forthcoming general election toward the end of May. 

AUD/USD has slipped in conjunction with other currencies against the greenback and is heading towards the 0.7000 region, which was pretty much where we started the year. The Kiwi has followed suit and has declined below 0.6500, last traded during the middle of 2020. 


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