10 February 2023

GBP

After last week’s sudden drop in the pound, with GBP/USD slipping from a top approaching 1.2500, to briefly testing support below 1.2000 earlier this week, the pound has stabilised over the latter part of the week, rising to 1.2200 at one point on Thursday. The broader pound has fared well, with GBP/EUR even managing to move above 1.1300 just yesterday. There has been a mixed bag of results amongst key UK housing price data, with the latest Halifax house price index implying a stabilisation of prices over the past month, which may be a reflection of softening yields at the long end of late, which has helped to reduce mortgage rates, albeit only marginally for now. However, ask surveyors and their latest measure of UK house prices tells a slightly different story, with the index actually deteriorating throughout January.

The latest UK growth figures have just been released this morning, and GDP declined by 0.5% over the past month, which was worse than the 0.3% drop estimated. However, it was not all bad news, as both Industrial and Manufacturing Production beat estimates, with the former increasing by 0.3% (-0.2% exp) and the latter flatlining (-0.2% exp). Total Business Investment also increased by nearly 5% over the past quarter (at4.8%), way ahead of the -1.9% expected.

Next week is a bumper one for UK data, with both consumer and producer price inflation set for release, coupled with the latest employment report and Retail Sales data, which collectively should give the BoE a much broader outlook on the shape of the UK economy, as they digest the impact (damage) of their cumulative rate hikes. As we have said before, the outlook on rates from the BoE looks uncertain, given a similar uncertain outlook for the UK economy. By way of example, the IMF think that the UK economy is likely to be the worst performing major economy amongst the major economies of the world this year, however, the National Institute for of Economic & Social Research (a think tank) will tell you that the UK economy is set to avoid slipping into a recession altogether. We always say that If you put twenty-four economists in a room, you will get at least thirty different opinions.

Back to the pound, and whilst sterling has bounced back with much aplomb throughout this week, the key inflation data is likely to set the tone for the pound’s fortunes through next week, as markets attempt to second-guess the BoE’s next move. On that note, the latest estimates call for a dip in headline inflation, with the chances of core inflation rising, given the lag effect on prices.

Thoughts from the dealing desk

-Oliver Taylor, FX Dealer

EUR

A week can be a long time in markets. This time last week, EUR/USD was sunning itself above 1.1000, the ECB were going to be hawkish for longer on rates, boosted by a recovery in economic activity in the region, and all talk was everything Euro-dominated being an outperformer. The single currency has certainly lost its shine since then, with EUR/USD slipping back below 1.0700 earlier in the week, and whilst much of that move has been down to a stronger USD (see USD), the more cautious tone from the ECB, coupled with some softening amongst key Euro area data releases, have played their part in the reversal too.

Amongst the data, regional Retail Sales slipped through December by 2.7%, and whilst a decline had been expected, the figure was worse than had been estimated. Whilst the ongoing impact of high inflation has clearly impacted consumer demand, there is a light at the end of the tunnel, and this week’s German inflation reading reflected a further decline from 9.6 to 9.2% (YoY) for the key harmonised index of CPI. Whilst softer inflation may be good for a country, is does not initially feed through to a stronger currency, given that it reduces the probability of imminent rate hikes.

Looking ahead, next week will see the release of the latest regional growth and unemployment as well as Spanish inflation (January).  As for the single currency, well much still depends on the ECB. They have already stated on many occasions (including this week) that they intend to hike rates by 0.5% at their next meeting, however, beyond that they will be assessing the cumulative impact to the economy, before deciding on their next move. Were the ECB to signal a pause, then further gains might be a bit harder to come by for the single currency.

USD

Having been on a one-way ticket from 114.00 since September last year, the dollar finally found worthy support over the past week, with the dollar index (DXY) rebounding from a low approaching 100.50 to over 103.00. Much of that move (back higher) has been down to stronger US economic data, with last week’s blowout 517K gains in headline payrolls a big driver, and confirming the ongoing strength in the US labor market, despite much talk around large lay-off’s in the tech sector. Indeed, the gains were backed-up by a reduction in the overall unemployment rate and a slight increase in the participation rate. Only a slowdown in wage inflation gave the (market) bulls a slight lift on the day. However, soon after, the latest ISM Services PMI also smashed back through the key 50 threshold to 55.2, underlying further strength in the US economy. Markets were rattled.

Focus then shifted to Jay Powell’s interview at the economic club of New York, and whilst he did reiterate that rates will have to move higher if jobs data remains robust, he seemed far less hawkish than expected, focussing on the increasing potential of a soft landing, and highlighting the chances of much weaker inflation through this year, even if the process may take some time. Overall, markets ended in slightly positive territory on the day, even if the outright moves suggested that algorithm traders were the big winners on the day.

After this week’s fairly slow data show, next week is a different animal, with the latest US inflation and Retail Sales data due. Whilst the dollar also rebounded earlier in the week, the gains (in the DXY) had been paired by the close of business yesterday. Amongst the major dollar crosses, USD/JPY continues to be a battle between bond sellers and the BoJ, with the pair moving between 131.50 and 130.00 for the most part, with the USD bulls slightly edging proceedings overall. The latest rumours are suggesting that Kazuo Ueda is to become the next BoJ governor, according to sources in Japan, which could be considered slightly yen bullish (USD/JPY bearish).

CAD

The big news for Canada comes in the shape of the latest employment report, unfortunately the data is released just a few hours after this week’s publication, so we will give an update in our daily comment on Monday. After the previous report reflected strong headline gains of over 100K, this month is expected to see a more conservative payroll gain of around 15K, with the overall unemployment rate likely to have risen slightly from 5 to 5.1%.

What we did get this week was an update from BoC governor Macklem, who had a more dovish tone to his comments, as he further outlined the BoC’s reasoning for pausing rate hikes after this month’s 25bps hike. He paid particular attention to the housing market, which much the same as in the UK, is sensitive to changes in interest rates. He stated that ‘rate hikes have hit homeowners hard’, and that how the ‘central bank needs time to gauge how households, businesses (are) adapting to higher rates before it makes further moves.’

USD/CAD remains rangebound, having moved between 1.3300 – 1.3500 since breaking lower in the early part of January. It is possible that today’s employment report could cause a breakout, but that move may well come on a bigger directional move from the greenback side of the fence.

AUD & NZD

The RBA hiked Australian rates by another 25bps earlier this week, raising rates to a 10-year high of 3.35% in the process. The move had been widely predicted by analysts, and so the market took its inspiration from the rather hawkish speech from the RBA governor Lowe, who made no mention of a likely pause (aka Canada), or any suggestion that Australian interest rates are at their peak. Of course, he also didn’t mention anything about rate cuts, but that would have been odd, given that they haven’t even reached their terminal level yet.

AUD/USD therefore rallied in the immediate aftermath of the RBA announcement, rising to 0.6950, and then peaking at just over 0.7000 just yesterday (Thursday). NZD/USD followed suit, reaching a top of 0.6389 at roughly the same time. Of course, both currencies are still trading well below the recent highs of 0.7150 and 0.6540 respectively, which were both reached this time last week when the greenback was really on the ropes.

Looking ahead, next week’s Australian employment data, plus another speech from RBA governor Lowe will likely dominate proceedings.