Neil Parker, our FX Markets Strategist, shares his views on the currency markets this week
United Kingdom: Bank of England meeting in focus as government steps up Covid booster programme
Last week was a bit of a standstill in terms of the UK data and events. The big release of the week from a data perspective was the October monthly GDP figures, which reported a very small increase in output, just 0.1% month-on-month, when a much larger 0.4% had been expected. The slowdown in growth came from a slump in construction output and a drop in industrial production, and despite services activity growing by 0.4% in October in line with expectations. There wasn’t much else for the markets to focus on last week, and GBP fell to fresh lows against the USD, but held up better against the EUR.
The new restrictions introduced last week, as a result of the Omicron Covid variant, could have a detrimental impact on the UK economy’s performance as we head into 2022. There are significant risks of a downturn in activity from the services sector, with businesses in travel, hospitality and retail all reporting that customer numbers have dropped since the announcement. If that translates into a sizeable contraction in economic output into the end of 2021, then it could have a material effect on what the Bank of England (BoE) decides to do. I don’t just mean at this Thursday’s Monetary Policy Committee meeting, but also in the meetings in 2022, when the markets expected significant action from the central bank to tackle the rise in inflation.
Ahead of this week’s BoE meeting, we get labour market figures for October/November and inflation data for November. Both were expected to lend support for the case to remove the monetary stimulus earlier, and so they still should, with the labour market data expected to show unemployment down and vacancies up, whilst inflation is set to rise to close to 5% on a headline consumer price reading. The BoE though should stand pat, and the data and surveys after the BoE meeting are likely to point to weakening consumer confidence and some renewed problems for high street shops, which would support the BoE’s decision.
The BoE can wait until February when there will be more analysis of the effects of Omicron on activity and further data on the inflation spike and labour market issues. Meanwhile, there is still some downside risk for the GBP against the USD. With some prospect of a drop in UK activity, and the Federal Reserve appearing to become more hawkish, are the risks tilted towards a move down to $1.30?
United States: Will the Fed stick with plans to end the taper earlier?
The recent data and surveys from the US continue to point to an economy that is performing solidly, though the pace of expansion does seem to have been arrested somewhat versus earlier in the year. The inflation data from last week pointed to a further increase in both the headline and core consumer price inflation rates, but no more than was expected. The confirmation of fresh three-decade highs for the headline and core Consumer Price Index rates will have cemented opinions in some parts of the Federal Reserve, but it is unlikely to be clear cut in terms of the path likely to be taken by the Federal Reserve when they meet on Wednesday.
The Beige Book, released two weeks prior, already indicated that there were still some supply chain issues to deal with and these had been hurting growth, and the latest employment report recorded a much slower pace of jobs growth than expected. So, whilst the Federal Reserve could speed up the pace of the asset purchase taper, asset purchases may still end later into 2022 than the market currently expects. More importantly, the Federal Reserve will update their dot plots, a graphical indication of where Fed members expect interest rates to be in 2022, 2023 and the long term. Will these have shifted dramatically? If they haven’t, the markets might have to revise their own thoughts on this matter, as the received wisdom is that the Fed are gearing up for substantial tightening over 2022 and 2023.
This week also sees the latest retail sales and industrial production figures due. Will these support the argument that growth in the US economy will remain solid heading into 2022, or will there be further signs that headwinds to growth are getting stronger as we approach the end of the year? For the US financial markets, there has been a lot of volatility in bond yields and equity values in recent weeks, with large rises and falls occurring as more data is gathered and statements made. Now that Jerome Powell is set to serve a second term as Fed Chair, is the path of monetary policy more obvious, or will it still be governed by the data, and the actions of the Federal government regarding fiscal policy?
One other question is whether the USD can sustain its momentum heading into 2022. Is there more upside to come, or will the USD be in for a more difficult trading environment in 2022? One can imagine that 2022 will prove more challenging than H2 2021 was.
Europe: ECB to stand pat as data and surveys disappoint again
The markets are not expecting the European Central Bank (ECB) to do anything on Thursday, and why would they? Yes, there has been a pick-up in inflation rates in Euroland, but at the same time there have been signs of slowing growth and rising Covid infections. These last two events are likely to have a greater short-term negative effect on the Euroland economy and give the ECB more breathing space for considering policy changes in 2022.
More importantly, recent forecasts from the European Commission indicated that growth would be slower in 2022 than previously forecast, and those forecasts probably didn’t account for the rise in Covid cases and shutdown of important parts of the Euroland economy. Last week’s data calendar was hardly jam packed, but the figures that were released continued to indicate a mixed picture in terms of activity.
This week’s ECB meeting is preceded by October industrial production figures and preliminary December manufacturing and services Purchasing Managers’ Index (PMI) indices. The Euroland October production figures should record a sharp increase in output, but the December PMIs are likely to record a sharp slowing in the pace of activity. The meeting is also preceded by Germany’s Institute for Economic Research (Information and Forschung) business climate survey for December. This is expected to report a slowing in German activity. That of itself is of little surprise, but with current conditions likely to be responsible for the bulk of the drop in the index, the pace of growth in Euroland is likely to see a further drag placed upon it.
The EUR continues to underperform as we head towards the end of the year. It looks unlikely that it will be able to scale the dizzy heights of $1.15 until there are more obvious and sustained data points which record an improvement in economic performance. The ECB are still likely to be slower to hike than other central banks, but it will be when those other central banks do decide to hike, versus expectations, that could be important in terms of the direction for the EUR against other majors. Expect more volatility in the EUR in 2022, as the data first becomes more conflicting and eventually signs a faster recovery.
Central banks: Poland, Brazil and Peru keep up the hikes; plenty of risks this week
Last week’s central bank meetings threw up no surprises versus expectations. The Reserve Bank of Australia left interest rates unchanged, as did the Reserve Bank of India and Bank of Canada. It was towards the latter half of the week that central bank announcements saw monetary policy tightened. First out of the blocks to hike were the National Bank of Poland, which hiked by 50 basis points, and warned of additional hikes to come in 2022. The Brazilian central bank hiked next, by 150 basis points, the same hike that they had made in October. There remains the risk that interest rates have to rise further, but how much damage will that do to the Brazilian recovery? Finally, the Peruvian central bank hiked by 50 basis points, once again to re-anchor inflation expectations and try and get on top of the recent inflation increase. That said, inflation rates may be starting to subside in Peru, which could limit the need to continue to tighten policy from here.
For this week, aside from the major central bank decisions, there are a number of interesting central bank meetings due. The Hungarian central bank are set to kick things off with a 30 basis point hike on Tuesday, followed by the central bank of Chile hiking 125 basis point later the same day. The Norges Bank is set to raise Norway’s key interest rate by 25 basis points to 0.5% on Thursday, followed by a raft of no change decisions by the Swiss National Bank, central bank of the Philippines and Indonesian central bank. Also on Thursday comes the Turkish central bank decision. Nothing would surprise the markets, but a cut of 1 percentage point in the interest rate to 14% is priced in. Further cuts from there would be unwarranted and could create additional weakness for the Turkish Lira. Later on Thursday, Banxico should raise interest rate to 5.25%, whilst the Taiwanese central bank leave policy on hold. Finally, on Friday, the Bank of Japan lead off with its decision, which is expected to be monetary policy unchanged, the Russian central bank is expected to hike 100 basis points, taking its official interest rate to 8.5% and the central bank of Colombia is predicted to raise interest rates 75 basis points to 3.25%. Overall, there are risks of a bigger hike from some of the South American central banks, and a larger cut from Turkey, which could prompt some significant currency volatility as FX volumes continue to drop.
View last week’s Quick Take.
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