Neil Parker, our FX Markets Strategist, shares his views on the currency markets this week
UNITED KINGDOM: UK yields surge as inflation pressures grow
The last week saw a surge in energy prices, which added to the list of supply-side issues the UK economy faces as we head towards winter. Even though energy prices fell back towards the end of the week, the consequence of the jump in natural gas prices was a rise in yields across the UK curve. New Bank of England (BoE) Chief Economist, Huw Pill, added to that rise in yields, suggesting that the current spike in inflation in the UK could be more lasting than previously thought, which could in turn accelerate the pace of official interest rates. Over the weekend, BoE hawk Saunders’ comments, published in the Daily Telegraph, suggested to expect earlier interest rate hikes, whilst Governor Bailey, in the Yorkshire Post, again expressed concern about spiking inflation rates. The rise in yields has gained further traction in the early part of this week, as inflation risks continue to rise.
The limited data and surveys last week were generally disappointing, with new car registrations down again in September, after an already sharp drop in August, and the Chartered Institute of Purchasing and Supply (CIPS) September construction
Purchasing Managers’ Index (PMI) dropping to its lowest level since January 2021. There was a small improvement in the CIPS services PMI, with the final September reading revised up to 55.4, which was slightly above August’s reading.
Data though wasn’t really responsible for the move in GBP. The rise in GBP/USD was, in part, down to the jump in yields, and also a bounce back from the drop in value at the end of the last quarter. Measured against that drop, the rebound is unremarkable. As for GBP/EUR, there are a number of factors continuing to constrain the EUR against other majors, not the least of which are the widening interest rate differential and worsening economic data. That trend may well persist for some time to come.
For this week, there are UK labour market figures for August/September released on Tuesday and a plethora of activity data for August released on Wednesday. The risks on the labour market figures are that they continue to show a sharp increase in wage inflation and that the pace of employment slows. If that then combines with worse than expected activity figures from the monthly Gross Domestic Product (GDP), industrial production, index of services and construction output data for August, the effect could prove significantly GBP negative. Even a reasonable set of UK data releases might not be sufficient to continue to trend a stronger pound.
UNITED STATES: US government avoids shutdown; payrolls undershoot again
The US economy was on the back foot again last week, with the jewel in the crown of the economic calendar, the US non-farm payrolls data, disappointing again. Net non-farm payrolls rose by 194,000, versus consensus expectations of a rise of 500,000, and though there was an upward revision to previous months’ payroll growth, that did not make up for the miss on the September figure. Not only that, but the participation rate slipped back also, suggesting the labour supply remains constrained. With average earnings rising and the unemployment rate dropping, the risk of labour-led inflation increases will continue to trouble the Federal Reserve as we head towards the next Federal Open Market Committee (FOMC) meeting.
Meanwhile, the US government managed to avoid a damaging shutdown, with the Senate agreeing to pass a short-term debt ceiling increase that has bought the White House a few more important weeks to sort out the whole unsightly mess. It is unlikely that the problems around President Biden’s big spending initiatives can be resolved on a bi-partisan basis, especially with important mid-term elections on the horizon. This could still prove damaging to the recovery and also to the USD if it continues to rumble on.
This week’s data includes September consumer price and producer price inflation, as well as retail sales. The data releases will prove important in terms of whether there are conclusive signs of a drop in inflation or weakening of the economy. If either or both are obvious, that could undermine the case for as rapid a change in the monetary policy environment as is priced for. The FOMC meeting minutes for the 22 September meeting are also released this week. These shouldn’t reveal anything particularly insightful, in terms of the economic outlook, but could provide a clearer picture about how the Fed intend to reduce the pace of monetary loosening and eventually hike interest rates. It is doubtful that the data or minutes will be particularly market-moving in FX terms, and the US dollar isn’t so far being supported by the rise in yields, which has also taken place in the UK and Euroland.
Euro stays under pressure as data disappoints
Last week, the data and surveys from Euroland were disappointing. Starting the week, the Euroland Sentix investor confidence for October fell more sharply than expected, to 16.9, the lowest reading since April when confidence was recovering. Then German industrial orders and industrial production figures for August were also disappointing, dropping far more sharply than had been expected. Irish and Dutch industrial production figures were also down versus July readings, and this week has begun with weakness in Italian industrial production, albeit far less severe than the falls seen in those other countries.
This weakness of data and surveys has continued to undermine the EUR against the likes of the USD and GBP. Indeed, the EUR has remained below $1.16 and £0.85, despite some signs of the sharp rises in energy prices abating, which could be part of the pressure being felt by manufacturers across the region. There remains some supply chain disruption that is set to persist, but this is unlikely to be worse for the Euroland economy versus that of the UK or US. Consequently, the EUR’s underperformance may begin to relent, so long as the data doesn’t get any worse.
With little data or surveys of any note this week, attention will likely concentrate around the German sentiment index survey, ZEW (Zentrum für Europäische Wirtschaftsforschung) for October, released on Tuesday, and also the plethora of speeches due from members of the European Central Bank (ECB) Governing Council members. Some of this could steady the ship, and not by the ECB members panicking and suggesting earlier intervention is necessary to stave off inflation pressures. Instead, if they project a calm, measured approach to tackling the inflation issues, then the markets may be reassured and this in turn will build confidence in the current ECB monetary strategy.
Central banks: Multiple hikes in rates last week; more to come this week
Last week saw the Reserve Bank of Australia leaving monetary policy on hold as expected. Another outbreak of Covid, this time the delta variant has undermined the recovery, and so the decision was highly unlikely to be anything else. The Reserve Bank of New Zealand raised rates to 0.5% as expected and the Peruvian central bank hikes rates by 50 basis points, to 1.5%, in line with consensus forecasts. Meanwhile, there were surprises from other central banks. The central bank of Romania raised rates by 25 basis points and so did the Central Bank of Iceland, taking both the official rates of Romania and Iceland to 1.5%. The National Bank of Poland also raised interest rates to 0.5% from 0.1%. All three central banks cited stronger inflation pressures as being responsible for the hike, although the National Bank of Poland was quick to dismiss the need for a series of tightenings.
This week’s central bank calendar sees the central banks of South Korea and Chile making their decisions. Both are expected to hike, with the South Korean central bank likely to plump for a 25 basis point hike, but Chile’s central bank is expected to hike by between 75-100 basis points. Inflation is again the justification for such moves, with the situation in South America having already prompted a hike from other regional central banks. South Korea’s decision to raise interest rates would, on the other hand, go against the current consensus in Asia, where fears of further Covid outbreaks and detrimental effects on economic activity has so far kept policy on hold in the vast majority of the region.
View last week’s Quick take.
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