31 March 2023

GBP

The BoE governor Andrew Bailey has been highly visible this week, reiterating the need for the BoE to keep focus on fighting inflation in spite of the bank wobbles, which have thankfully missed the green and pleasant shores of the UK (so far). At the same time, Bailey also highlighted the ongoing strength and robustness of UK banks, and that the BoE will not be unduly worried about the health of the global financial system. Strong words, and similar to Christine Lagarde’s comments last week, they may have played a part in calming a nervous market.  

Aside from Bailey’s regular updates, it has been a fairly slow week for key UK data, although the latest quarterly UK growth figures, which were released a little earlier this morning, were probably the pick of the bunch. Having previously been expected to slip into a recession, growth has surprised to the upside, with a 0.1% increase (QoQ) and 0.6% (YoY). In both cases, the data exceeded estimates.

As for the pound, well that powerful combination of a broadly weaker dollar, and the market perception of underlying strength amongst UK banks, has helped to ensure that GBP/USD has risen all of the way to just over 1.2400 through this week. Whilst the 1.25% gain might not sound like much of a move, it has helped to take us all the way back to levels not witnessed since the early part of the year. However, before sterling bulls get too carried away, 1.2500 remains the big topside level to watch. As for next week, the latest PMI’s, House Prices and the Easter holiday are likely to dominate proceedings.

Thoughts from the dealing desk

This commentary does not constitute financial advice

-Daniel Jones, Dealer

EUR

There were some significant differences between the latest Spanish and German inflation reports, which were both released yesterday (Thursday). Spanish inflation really caught the eye, with Harmonized yearly inflation almost halving, yes halving, over the past month from 6% to 3.1%. Markets had been expecting figure around the 4% mark, given the big drop in energy prices. It was not such good news in Germany, with Harmonized CPI dropping from 9.3% to 7.8%. Granted, the figure reflected a sharp drop, but markets were hoping for a dip to around 7.5%, and probably even more given the earlier Spanish report.

The problem with inflation is that, aside from energy, most other key components remain annoyingly sticky. That could be witnessed by the moves in the bond market after the data was released, with yields rising across key German bonds, especially at the front end, as the key two-year Bond saw its yield rising 0.15% to 2.78%. The two-year bond is especially sensitive to perceived interest rate changes, with markets clearly gearing up for further ECB hikes as they maintain their hawkish outlook, in spite of the recent banking wobbles. The ECB’s chief economist Philip Lane suggested this week that more rates hikes would be needed, assuming bank woes are contained, of course.

The single currency has rebounded well after initially being sold off after the SVB worries intensified a couple of weeks ago (already). Indeed, EUR/USD moved back over 1.0900 yesterday (Thursday), and could well benefit from further inflows, assuming that the status quo remains in place for key bank stocks. GBP/EUR remains trapped between 1.1300 – 1.1400, given the strong performance of the pound of late.

Next week’s shortened schedule sees key data shoehorned into four days, with the latest PMI readings probably the pick of the pack.

USD

The greenback is not having the best of runs at the moment. Markets had been quick to reprice future rate hike expectations from the Fed, given the likely impact from tighter credit conditions would have on growth projections and economic outlook, with the sudden 180 degree change that came in light of the banking wobbles. That has fed into a much weaker dollar, and markets have since been slow to unwind the pricing, firmly believing that the Fed will be cutting US rates later this year, maybe by as many as three times before Christmas.

Assuming (and it is a big assumption) that the bank wobbles are in the rear view mirror, there is every chance that the Fed will revert back to pre-crisis mode, and any future moves on rates will be decided on incoming data. Even if inflation might be on the way down, core inflation still remains painfully sticky and some way above the Fed’s target level, so we cannot completely discount further rate hikes from the Fed in the coming months.

Therefore having taken a back seat for a spell, data is likely to become ever more significant, and today’s Core PCE Price Index, which is the Fed’s referred measure for measuring inflation, will be the first big test in what has otherwise been a fairly quiet week. Any signs of weakness and risk assets are likely to push higher, and vice-versa. As for the dollar, well the dollar index (DXY) is edging towards the key 100.00 region, which proved to be decent support for the greenback previously, but the composition of the index is weighted strongly in favour of EUR/USD, so the decline is perhaps not that surprising.

Elsewhere, the broader dollar has also found the going tough, with USD/JPY being the one big exception. A big unwind of recent safe-haven flows has resulted in a sharp bounce for the pair, which is now trading around 200pips from Monday’s low.

CAD

It has been a great week for the Loonie, with USD/CAD dropping by over 1.5% (so far). You would have to go all of the way back to November last year to see the Loonie surge by that much in a week, notwithstanding today’s close. The pair has also now declined to test levels not witnessed since the middle of February.

Aside from last week’s stronger Canadian Retail Sales increasing the perception that the BoC could/might be persuaded into un-pausing rate hikes again, oil prices have found some support and the weaker greenback has also played a part in driving ongoing Loonie strength.

On the BoC, we would not really believe that the BoC are expected to have a change of heart based merely on one Retail Sales release. Indeed, for that to happen we would need to see much more robust surges in Canadian economic activity, and that has not looked likely at the moment, based on incoming data.

Next week is all about the March employment report, and having risen by 21.8K through February, headline Net Change in Employment is expected to moderate, albeit with the overall unemployment rate remaining at a steady 5%. Onwards and upwards.

AUD & NZD

Neither AUD/USD or NZD/USD have really been able to capitalise on the weaker greenback through this week, with the former stuck between 0.6630 – 0.6700 for the most part, and the latter between 0.6200 – 0.6250. Data has not been helpful, with headline inflation dropping for the second month in a row from 7.4% to 6.8% and the latest Australian Retail Sales data rising by a meagre 0.2% over the past month, having been expected to have risen by around 0.4% through February. Granted, there was a whopping 1.8% jump in the previous month, but markets can be cruel.

With inflation softening, there is every chance that the RBA could pause from hiking rates at next week’s key policy meeting, although the outcome is still probably too close to call. Australian interest rates currently sit at 3.6%. The RBNZ meet a day later, and despite New Zealand rates being up at 4.75%, they have indicated (after their last meeting) that they expect to keep tightening, given that inflation in New Zealand currently remains too high.