What’s happening with currencies this week? Neil Parker, Market Strategist shares his views.
United Kingdom: GDP (Gross Domestic Product) beats expectations; focus on the Bank of England
Last week was all about what the UK economy did in January. The news was positive, in that the contraction in output associated with the latest lockdown was much smaller than forecast, at -2.9% m/m (month on month), whilst the economy had been expected to contract by almost 5%. The services sector held up better than expected, contracting by 3.5% m/m versus a 5.5% decline. Construction output also rose unexpectedly, up by 0.9% m/m whereas it had been predicted to fall by 1%. Prior to that February survey evidence via the BRC (British Retail Consortium) retail sales and the RICS (Royal Institution of Chartered Surveyors) house price balance releases reported a rebound in like-for-like retail sales values and an unanticipated bounce in house prices. The signs are that the UK economy is, in general, improving and was not as badly affected by the latest lockdown as it had been past lockdowns.
As far as the GBP was concerned, having backed away from the $1.40 region the week before last, there was a brief push back above that level at the back end of the last week. There was also a push back up towards €1.17 in GBP/EUR, but the moves were not sustained as the return of rising yields took the wind out of the GBP’s sails.
All eyes this week are likely to be on the BoE’s (Bank of England) Monetary Policy Committee meeting and minutes, due at midday on Thursday. The working assumption in the run up to the meeting that all forms of monetary policy will be left on hold, but with the likes of the ECB (European Central Bank) and RBA (Reserve Bank of Australia) accelerating bond purchases to tackle increases in yields across the curve, could the BoE surprise as well? Comments in the aftermath of the February decision were that, whilst the Bank were pleased that the economy had not suffered as much as feared, inflation and employment were a long way from levels that would prompt any consideration of policy change. Furthermore, the Bank made it clear any monetary policy tightening would likely be a long way after the UK re-attained its pre-pandemic output levels. It would seem that the Bank of England Governor, Andrew Bailey, is not concerned by the rise in yields seen in recent months, believing that this is driven by increased recovery confidence. Would the Bank diverging from the ECB’s path of front-loading bond purchases help the GBP? It might.
Also this week, public finances data for February are expected to report a widening in the deficit from January, but that will be because January is a key tax receipts month. The ongoing funding of business and employee support will maintain the elevated level of deficit, but could the stronger economic performance (versus expectations) offer the risk of a smaller deficit and a stronger GBP? Perhaps, although the BoE decision, and bond market reaction is likely to be a more significant influence on the FX markets.
United States: Biden stimulus signed into law; what will the FOMC (Federal Open Market Committee) do?
In the middle of the week, the US House of Representatives voted in favour of the modest tweaks the Senate made to the $1.9 trillion stimulus plan. That allowed for US President Joe Biden to sign it into law later in the week, and the US Treasury to start printing the cheques. The financial markets remained volatile, with yields rising, falling and rising again over the course of the week, and equity markets also finding direction difficult. Efforts to calm expectations of an early taper of the asset purchase programme from the Federal Reserve did not quell that market volatility, and the US dollar retained most of the gains it had made the previous week in the last week.
The US President also announced that the administration were trying not only to supercharge the economy, but also the vaccination effort, suggesting that all adult US citizens would be offered a vaccination by late May, which would take a massive increase in vaccine shots delivered against the current pace.
Last week’s data and survey releases were thin on the ground. The consumer prices data for February recorded a jump in the headline inflation rate, to 1.7% y/y (year on year) from 1.4%, but the core inflation rate dropped to 1.3%. Consumer sentiment rose in the provisional March reading, according to the University of Michigan, perhaps as the prospect of stimulus cheques were seen supporting consuming spending, and the other limited data released recently reported more consistent signs of improvement.
This week is all about the FOMC meeting. The Federal Reserve’s words have not been sufficient to quell the rise in yields, so will it also resort to front loading the asset purchases? Will that work, given that it hasn’t with other central banks and it may now be the predictable move? Could the Fed surprise the markets with more aggressive monetary action, if they are concerned about the damage rising yields will do to the growth and inflation outlooks? What could the Fed meeting mean for the US dollar? Will it be able to hold onto recent gains, or are markets still predominantly negative on the dollar, as they have been for the last three months?
Europe: ECB frontload pace of asset purchases as worries over yield curve rise increases
The big story of last week was the decision by the European Central Bank to accelerate the pace of asset purchases for the next three months, from the current weekly level of €14bn. What that might rise hasn’t been made clear, but it is likely to be between €18-20bn per week. However, the ECB suggested the growth risks were more balanced than previously and did not increase the overall size of the PEPP (Pandemic Emergency Purchase Programme). The decision to accelerate the asset purchase programme came after there was further adverse activity in government bond markets, prompting a further rise in yields. The central bank will have been concerned about the effect this unofficial tightening in monetary conditions might have on economic activity particularly business investment in any post pandemic recovery.
In terms of data and surveys, last week was quiet. Final Q4 GDP figures from Euroland disappointed, recording a marginally larger fall in GDP than previously reported, the weakness coming from smaller quarterly growth in government expenditure versus expectations. Industrial production figures for January were a mixed bag, Germany recording a very sharp contraction, but France recording an outsized expansion. The net impact was that Euroland production rose more than expected in January and reported a year on year expansion for the first time since October 2018. The EUR, under pressure in previous weeks, staged a comeback, albeit brief and not sustained.
This week, the key releases are the German March ZEW (Zentrum für Europäische Wirtschaftsforschung / Germany’s Sentiment Index) survey, on Tuesday, and final February Euroland consumer prices release on Thursday. The ZEW should record some additional improvement in both expectations and the current situation, with the recent announcement that although lockdown was to be extended it would be less severe, helpful in terms of the re-opening of some businesses. As for the Euroland consumer prices release, that should report the headline rate remaining at 0.9% y/y, and the recent ECB meeting indicated no reason to revise the forecast for inflation to rise to 1.4% over the course of 2021. Nothing in these releases to hurt the EUR, but the general sentiment of higher yields may continue to hurt EUR/USD this week.
Central banks: Bank of Canada stands pat; Brazil and Turkey to hike?
Last week there were fairly few central bank meetings to focus on, but one stood out. The BoC (Bank of Canada) decision on monetary policy was not about what would happen on interest rates, but whether there would be any shift in the asset purchase programme. The BoC decided not to alter the programme, with the rise in yields, which could have brought about an acceleration of bond purchases, counterbalanced by the stronger labour market data at the end of the previous week. Neither the Central Bank of Kazakhstan or the Central Bank of Peru did anything on monetary policy either, and the market attention was elsewhere, given the ECB meeting and announcement.
This week, with two big central bank decisions due on Wednesday and Thursday, what else is there to look forward to? Plenty as it happens, with the Brazilian central bank meeting on Wednesday predicted to result in a 50 basis point hike in the Selic rate, and the Turkish central bank meeting expected to raise the repo rate 1 percentage point from 17% to 18%. For Brazil, a sharp increase in the USD/BRL exchange rate has been unhelpful for the central bank, and although it has pulled back from recent highs over 5.80, a precautionary tightening is likely. As for the Turkish central bank, a rise in inflation and a more volatile lira are likely to be sufficient to support the case for tightening, with the authorities concerned by the threat of renewed FX weakness.
There are also meetings for the central banks of Indonesia, Norway and Taiwan, but none are expected to make any moves on policy rates from current levels. That said, the Norges Bank are likely to be fairly happy with recent data, which has been better than expected, and the rise in oil prices. If anything that could bring forward the timing of any reversal of current monetary policy.
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