03 February 2023

GBP

The Bank of England delivered another 50bps rate hike this week, raising UK rates to a 15-year high of 4% in the process. In doing so, the BoE also delivered what we in markets might refer to as a ‘dovish hike’, which may sound like a gymnastics move, but really only suggests that the BoE may be readying for a pause, at the same time as just raising rates. In their accompanying guidance, the BoE dropped the need to act ‘forcefully’, even if Andrew Bailey highlighted in his post-match conflab the ongoing need to battle inflation. There was also a slight tweak in the voting pattern, with the 7-2 vote in favour of the hike, and those two dissenters calling for no change. Interestingly enough, the BoE’s Mann also reduced her previous vote from 75bps to 50bps.

We have suggested in our daily commentaries this week that the BoE may not be in the position to hike UK rates after this meeting, given the weakening UK economy and gloomy outlook. The good folk at the IMF also predicted that the UK will be the only major economy to contract through 2023, with their latest guesstimates suggesting a 0.6% contraction, beating the likes of Russia to the bottom spot, although the BoE now think that a recession is likely to be much shallower than previously expected. In the meantime, given that there has been a myriad of different public sector workers striking over pay and conditions over the winter, it is no surprise that productivity has been diminishing.

On the data front, the latest update from the Nationwide highlighted the further decline in house prices, which declined by 0.6% throughout January, which is the worst run since 2009. Of course, these figures are likely to deteriorate further once the latest rate hike from the BoE eats into borrowing appetites. Next week will be dominated by the latest growth figures, which are expected to rebound after the previous month’s decline of 0.3%.

As for the pound, well GBP/USD had held up pretty well through the past week, until the BoE meeting put paid to that, with the pair slipping back below 1.2250. However, the broader dollar moves will still have a big say on directional bias. As for the broader pound, well there has been emerging weakness, highlighted by the decline in GBP/EUR, which dipped under 1.1175 yesterday (Thursday) afternoon.

Thoughts from the dealing desk

-Oliver Taylor, FX Dealer

EUR

The ECB followed the BoE, and raised Euro area rates by 50bps to 2.5% yesterday afternoon. In total, the ECB have now raised rates by 3% since last July, as they intensify their battle to fight inflation in the region, even if the numbers have been softening of late. In her press conference, ECB president Christine Lagarde also confirmed that the ECB would be raising rates a further 50bps at their next meeting in March. Beyond that meeting, the outlook has clouded a tad, with Lagarde suggesting that the ECB would ‘evaluate the subsequent path of its monetary policy’, which is central bank speak for checking that the wheels have not fallen off, before making their next move.

That last bit led some analysts to predict that the ECB are likely to pause rate hikes beyond March, which seems to have been the conclusion from the bond market, with yields rapidly evaporating amongst key Euro area government bonds. By way of example, yields on the 10-year Italian government bond slipped over 40bps on the day, which is quite some move in bond-land. The collective news of potential pauses on the horizon from all 3 of the Fed, ECB and BoE soon enough spurred a big rally in risk assets, with the interest rate sensitive Nasdaq, posting another + 4% jump at one point on the day.

Whilst most of the recent data in the region has been supportive of further rate hikes, including growth recovering over Q4 (up 0.1%, from -0.1% prior), some of this week’s data has not quite hit the mark. In particular, Retail Sales in Germany slipped 5.3% through December and Spanish Inflation unexpectedly increased, despite regional figures easing further. That may have had an impact on the ECB’s rhetoric.

As for the single currency, EUR/USD broke over 1.1000 for the first time since last April in the immediate aftermath of the Fed (not ECB) meeting, however, Lagarde’s somewhat less hawkish comments led to some profit taking, with the pair slipping back below 1.0900. Next week’s regional Retail Sales look the pick of the bunch.

USD

As expected, the Fed reduced the pace of rate hikes for the second month in a row, raising US rates to a target level of 4.5 – 4.75% in the process. In their accompanying statement, the Fed maintained that ‘ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time.’ That news was never going to move markets, given the Fed’s excellent forward guidance. However, Powell’s post-meeting conference did move markets, and whilst he appeared to attempt to maintain a hawkish outlook at times, his comments referring to ‘encouraging’ signs that price pressures were easing, coupled with confirmation that the US economy’s disinflation process has started, were enough to convince markets that the Fed are gearing up for a pause and signal a big rally in risk assets.

It was always going to be a tough ask for Powell, given that it is hard to remain hawkish when you have reduced the pace of rate hikes for two months in a row, and recent economic data has reflected signs of softening of late, such as last week’s softer ECI (Employment Cost Index) and the Core PCE, both closely monitored by the Fed. As we have highlighted of late, given the disconnect between the markets expectation for the future path for US rates, with cuts currently priced into the latter part of this year, and the Fed’s own dot-plots suggesting a long pause, incoming data is far likely to be the driver to risk appetite and therefore the greenback’s direction.

On that note, today’s (Friday) payroll data for January will have some added spice, with any weakness likely to give market bulls (and dollar bears) another reason to extend the recent trends, and vice-versa. Markets currently expect a 185k gain, after last month’s healthy 223K increase. The latest ADP (private payrolls) and JOLTS data did not give us many clues, with the former slipping, but the latter beating estimates. Today also sees the release of the latest ISM Services PMI, which is expected to bounce back over the key 50 threshold.

As for the dollar, well the dollar index got within 50pips of the key 100 region, but the combination of the ECB and slightly less jobless claims rescued the greenback on the day. Amongst the major dollar crosses, USD/JPY continues to remain heavy, slipping back to as low as 128.00, as yields on the 10-year JGB remain stuck to the BoJ’s 0.5% ceiling. After an abundance of keynote data and meetings this week, next week looks a far quieter affair.

CAD

Having spent a while bouncing between 1.3300 and 1.3500, USD/CAD finally broke below 1.3300 this week for a spell. Helping the cause has been incoming data, with the latest growth data for Canada beating estimates, with GDP increasing by a whopping 0.1% over the final quarter of last year, matching the previous quarter. On an annual basis, GDP likely gained 1.6% in Q4. There was also a surprising jump in Manufacturing, with the S&P PMI rising to 51 from 49.2. Markets had been expecting a much smaller increase to around 49.4. As we often say, anything over 50 represents an expansionary economy, so that jump was well received.

Unlike the US (which is out for release today), we will have to wait another week for the January Canadian employment data, so the Loonie is once again likely to take its directional bias from broader market sentiment, given a dearth of keynote data releases before then. Despite that recent break below 1.3300, the lack of sustainable follow through will still remain a concern for the Loonie bulls amongst us.  

AUD & NZD

December was not a great month for Australian retailers, with Retail Sales slumping 3.9% (MoM), reversing the strong gains in November and throughout the year, and falling well short of analyst estimates, which were centred around the -0.3% mark.

The next RBA meeting is scheduled next week, with the RBA expected to hike Australian rates by another 25bps, given that headline inflation remains frothy at 7.8%. However, with those weaker Retail Sales and weaker than expected employment data, this coming meeting may see the RBA join the likes of the BoC and opt for a pause from then on. Where have you heard that before?

The latest New Zealand employment data missed estimates, with a 0.2% change during Q4, against an expected 1.3% jump. Whilst still impressively low, overall unemployment increased to 3.4%. Both AUD/USD and NZD/USD have had sideways weeks, with the former remaining over the 0.7000, but below the 0.7160 top, and the latter sitting at just under 0.6500, having briefly tapped a new cycle top at 0.6538 just yesterday (Thursday).