24 February 2023

GBP

The recent trend of gradually improving UK sentiment, aided by stronger than expected economic output continued through this week. The latest PMI report saw both the Composite and Services components move strongly back over the key 50* threshold, with the former surging from 48.5 to 53 and the latter rising from 48.7 to 53.3. Manufacturing also improved, jumping from 47 to 49.2, and falling just short of the magical 50 level*.

On the same day, the latest UK public sector finances were released. During January, there was a surprising £5.4bn surplus against an expected deficit of around £7.8bn, with the increase boosted by a big surge in tax receipts. The yearly figures also highlighted a strong beat, with the public sector borrowing around £111.9bn, which was roughly £30.6bn less than had been forecast by the OBR, just a couple of month’s back in November. That is a big beat.

The improvement in public sector finances could see the government use the extra cash to give muted 5% pay rises across the board to public-sector workers, who have been striking relentlessly throughout the winter in a bid to improve their pay and conditions. The government might alternatively use the extra cash to help fund extra spending plans. With the March budget just around the corner, the timing really could not have been any better for the government.

The broad pound has responded well to the news, with the likes of GBP/EUR moving up strongly over the past week from around 1.1200 to just under 1.1400. GBP/CAD rallied from 1.6100 to 1.6400 at one point. GBP/USD is an altogether different animal, and having initially rallied as high as 1.2150, suffered losses alongside most of the other major currencies against the dollar, slipping back towards 1.2000 by the end of the week. Next week will be dominated by the latest speech from BoE governor Andrew Bailey, to see whether there has been any material change on the BoE’s rate outlook, given that improving backdrop. Indeed, the BoE’s Catherine Mann was on the wires earlier in the week, suggesting that further rate rises will be needed to arrest sticky inflation.

*Above 50 is considered expanding, below 50 is considered contracting for an economy

Thoughts from the dealing desk

-Daniel Jones, Dealer

EUR

With Core regional Harmonized inflation surprisingly rising to 5.3% (YoY/Jan) from 5.2%, it is perhaps no surprise that the ECB continue to imply that they will definitely be hiking euro area rates by another 50bps at their next meeting. Whilst not rising, the stickiness of German inflation will also be a key factor impacting the ECB’s thinking. However, the majority of the other key data releases have shown upside surprises, which should give the ECB much more confidence to maintain the current rate trajectory.

Amongst that other data, there was a bit of a mix bag amongst the latest German IFO survey. Whilst Business Climate and Current Assessment missed expectations, the Expectations component rose, which suggests that businesses expect better conditions looking forward, which is a fair assessment, given improving sentiment across the region.

Having been on a solid run from September until the end of January, the single currency has found the going much tougher this month, with EUR/USD slipping from a high of over 1.1000, to under 1.0600 by yesterday, primarily driven by the surging greenback. That dynamic is likely to persist for the time being, unless the ECB move to an even more hawkish outlook on rates, or the Fed start to get all dovish on us. Looking ahead, key unemployment and more inflation data are both set for release across the region next week.

USD

It has been another solid week for the dollar bulls amongst us, with the dollar index (DXY) moving back over 104.00, driven by stronger US data (again) and broadly weak risk sentiment. Amongst the key dollar crosses, USD/JPY rallied back over 135.00 for a spell, despite the yield on the 10-year JGB remaining over the BoJ’s ceiling price of 0.5% throughout the week. Clearly the move higher in US yields is more telling for the pair, however, the latest Japanese inflation reading, which was released overnight saw National CPI rising to 4.3% (from 4%), albeit slightly under estimates of 4.5%. The big news came in the shape of the first keynote speech from incoming BoJ governor Kazuo Ueda, who reiterated that it is ‘appropriate’ for the BoJ to continue its easing and would not get into the specifics of YCC for now. However, his comments caused some choppy moments for USD/JPY overnight, and perhaps tellingly, the yield on the 10-year JGB finally moved back under 0.5% after his speech.

On the data front, the latest US PMI report followed the likes of the UK and Europe, with the Composite moving up from 46.8 to 50.2, and the Services component rising to 50.5 from 46.8. In other news, the latest preliminary Core Personal Consumption Expenditures (PCE) rose from 3.9% to 4.3% over the past quarter. On the downside, the preliminary Q4 GDP reading missed estimates, rising by 2.7% versus 2.9% expected.

The FOMC also released the minutes of their latest meeting in the middle of the week. As we have highlighted previously, we suspected that those minutes had the potential to look somewhat stale, given that the meeting came before the recent bout of super-strong US data releases of late. Whilst a couple of members did vote for a larger 50bps hike, the majority of members opted for a 25bps move. There was little ‘new’ news for markets to digest for the most part, aside from helping to create some short-term volatility on the session.

Overall risk sentiment has also wavered, as markets increase their expectations for the Fed’s terminal rate, driven by that strong data, which has clearly been a drag on equities and helped to raise Bond yields. That environment has naturally helped to support the dollar, hence the move in the dollar index. Looking ahead, today’s release of the Core PCE Price Index will be key, given that the Fed openly admit that they play particular attention to it. Beyond that, markets will also be listening to incoming comments from the ’mainstream’ voting fed members, to see if they have shifted to favouring larger rate hikes moving forward.

CAD

The big news from Canada this week came in the shape of the latest inflation and Retail Sales data. Inflation really caught the eye, and both the headline, at 5.9% (YoY) and core prints at 5% (YoY) came in below estimates, with the latter having been expected to come in at around 5.5%. The news should help to vindicate the BoC, who recently announced that they will be pausing their cycle of rate hikes to assess the impact of the cumulative moves on the economy.

Retail Sales jumped 0.5% in the latest data, up from 0.2% expected. Much of the increase can be attributed to rising auto sales, coupled with merchandise stores increases. The powerful combination of a stronger greenback, softening Canadian inflation and (thankfully) weakening oil prices helped to finally drive USD/CAD out of the 1.3300 -1.3500 range, with the pair moving as high as 1.3580 during the past week, as the Loonie buckled under the pressure.

Looking ahead, the latest Canadian growth data will dominate proceedings for the Loonie next week, with Q4 growth expected to have declined from 2.9% to 2.1% on an annualized basis.

AUD & NZD

The RBNZ raised New Zealand rates by another 50bps to 4.75% this week, in a move which had been expected, despite doubts being cast about the size of the hike given the recent cyclone. New Zealand rates now sit at a 14 year high, and the RBNZ are not finished yet, indicating there’s further tightening still to come whilst inflation remains high. Their current projected terminal rate is at 5.5%, which they expect to reach later this year.

The RBNZ also said that it was too early to assess the policy implications of the devasting cyclone, but they will look past the short-term price pressures stemming from the ‘extreme weather events.’

In Australia, the latest PMI report beats estimates, with Manufacturing rising to 50.1 from 50, and Services jumping from 48.6 to 49.2. It is a big week for Australian data next week, with both Retail Sales and the latest growth figures set for release.

NZD/USD rallied for a spell on the back of the RBNZ’s hawkish tones, but the pair succumbed to that ever-strengthening greenback, dropping back to 0.6200 by yesterday (Thursday) afternoon. AUD/USD mirrored the Kiwi, slipping back to below 0.6800 for the first time since the beginning of February.