Neil Parker, our FX Market Strategist, shares his views on the currency markets this week
United Kingdom: GBP starts the year in buoyant mood as economic optimism builds
The pound performed solidly in the first week of 2022, rallying against the EUR to within a whisker of €1.20 and rebounding back above $1.35 against the USD. The start of the year has been encouraging for the GBP predominantly as it appears that the UK government’s decision to only impose light restrictions on the economy may have paid off. Although the number of infections has increased, the level of hospitalisation and deaths with Covid have not jumped as much.
The financial markets now price for almost a full percentage point of increases in UK interest rates this year. In effect that is one hike per quarter. In my view, it is unlikely that the Bank of England will hike more than that, but they could conceivably hike by less. Consequently, on the UK interest rate argument alone it is not clear where further momentum for the GBP might come. Similarly, for economic activity, the markets are predicting growth of between 4.5-5% for the UK in 2022. Is it realistic to anticipate faster growth than that? Probably not, in my view. So purely from a domestic growth perspective, it is not clear that the GBP has much additional upside either.
Last week’s limited data and surveys offered little support or risk to the GBP, with the manufacturing and services Purchasing Managers’ Indices (PMI) revised up to 57.9 and 53.6 from provisional December readings of 57.6 and 53.2 respectively. The construction PMI survey for December saw the index drop from 55.5 to 54.3 but that was marginally better than consensus forecasts. The only other data release was November lending to individuals from the Bank of England. This recorded a rise in both unsecured and secured lending, with the latter hardly a surprise given the ongoing strength in the housing market.
This week, the focus is on the activity data for November released at the end of the week. The markets will be expecting a further solid bounce in activity, including in GDP growth, but are the risks marginally to the downside? If they are that could upset the recent GBP rally, if only momentarily. These releases are the beginning of an intense period of UK data and survey outturns, including December consumer prices, November/December labour market figures, December retail sales and January consumer confidence. Those are due in the week commencing 17 January and could have a significant influence on whether the Bank of England hike again in February or not.
Can the GBP push higher again this week? The markets may well want to test €1.20 and $1.36, but it is difficult to envisage any domestic triggers for any sustained break higher, in my opinion.
Europe: Euroland continues to present a mixed bag of data and surveys
Last week’s limited data and survey calendar from Euroland only served to further muddy the waters regarding the current economic conditions being experienced by the economies in aggregate. The manufacturing PMI index remained at 58.0 in the final reading, unchanged from the preliminary outturn; German and Spanish unemployment continued to fall, and by more than expected; and the Euroland services PMI fell to 53.1 from an initial reading of 53.3, thanks to larger drops in Italian and Spanish readings. German factory orders rose in November by more than forecasts, but production fell in the same month as did French industrial production, whilst Euroland economic confidence fell in December after a sharp drop in services confidence. Finally, Euroland consumer price inflation was marginally higher in December, when it had been expected to drop back.
The EUR made some limited gains against the USD, but did not perform well against the GBP, where the EUR reached fresh 22-month lows. The likelihood that the ECB will be slower to hike interest rates than the US or UK is already embedded in market thinking, so is there much further for the EUR to slip? Undoubtedly the further rise in headline inflation rates in Euroland will be uncomfortable for the central bank, but there are some signs in other countries, and regarding commodity markets that price inflation may be peaking and start to slip back.
For this week, the markets are set for another quiet week on the data and survey front. There aren’t even any major speeches from ECB officials due, so it is unlikely the EUR will get much support from data, survey or events. The hope may be that the equity markets will recoup some of the losses seen into the end of last week, but the question remains what will be the driving factor or factors behind this? If risk appetite remains under pressure, the scope for further EUR gains looks limited against other majors, in my view.
United States: US Federal Reserve ready to speed up hikes as payrolls disappoint again; Beige Book released this week
The US Federal Reserve indicated in the minutes of the December FOMC (Federal Open Market Committee) meeting that they were ready to accelerate the pace of monetary tightening, in the face of what look to be more medium-term inflation pressures. There have also been indications from the Job Openings and Labor Turnover Survey data that the US labour market is experiencing an extended period of disruption, with more employees quitting to take up better paid alternative roles.
Consequently, the Federal Reserve continue to look on course to end the asset purchase programme by the end of March and set to raise interest rates multiple times in the remainder of 2022. However, last week did see another disappointing outturn in terms of the US non-farm payrolls data for December. Payrolls rose by 199,000 in December, less than half the market consensus, although the news from the household survey was better, with the unemployment rate falling to 3.9% from 4.2% in November.
This week sees the release of US December consumer price inflation figures, along with producer prices, retail sales and industrial production. Inflation is expected to rise to fresh highs, retail sales are forecast to have contracted slightly, whilst industrial production is forecast up slightly on November’s. However, these figures are likely to be secondary to the Federal Reserve’s Beige Book, an analysis of current conditions for the US economy. Unless the Fed’s current assessment of the US economy is significantly different from how they found things in December, which seems unlikely, the Fed is set to continue its asset purchase taper at the current pace and is on course to tighten monetary policy in late Q2 or early Q3.
The USD is giving back some of the H2 2021 gains it made, but it is simply too soon to know whether the losses seen in the past week or two represent a trend or just profit taking. This week’s data won’t make that judgement any clearer, in my opinion.
Central banks: Poland and Peru hike last week; Romania and South Korea in the spotlight this week
Last week saw the National Bank of Poland (NBP) and the central bank of Peru both raise interest rates. The NBP led the way with a further 50 basis point increase in reference rate, taking it to 2.25% – the highest level for Polish interest rates since September 2014. The reasons were the same as previously, in that the central bank finds itself struggling to contain inflation pressures, with consumer price inflation hitting a double decade high. Peruvian interest rates also jumped by 50 basis points, to 3%, but that was only the highest since October 2018. Both central banks hinted at more interest rate hikes to come, as inflation was not expected to drop back to target within the forecast horizon.
For this week the focus is on the central banks of Romania and South Korea. The Romanian central bank is set to hike interest rates by 50 basis points to 2.25% and following on from that announcement should see inflation tick up slightly in the December reading, albeit slightly. The Bank of Korea is set to hike interest rates to 1.25% from 1%, but the decision is seen as balanced between the menace of inflation versus the Covid pandemic. Overall, the hit to activity should limit the necessity for higher interest rates. The markets will be closely watching these decisions, to see how determined central bankers really are in the fight against inflation, when faced with the potential for slower economic growth.
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