FX outlook: Parky’s quick take – 19 July 2021

19 July 2021

Neil ParkerFX Markets Strategist

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What’s happening with currencies this week? Neil Parker, Market Strategist shares his views.

United Kingdom: GBP struggles despite a shift in tone from Bank of England policy makers

Sterling started the week lower against the dollar and EUR amid concerns about soaring Covid-19 cases. Last week saw a shift in tone from Bank of England (BoE) policymakers, with Monetary Policy Committee member Michael Saunders suggesting that the question of whether to curtail current asset purchases early would be under consideration at their upcoming meetings. We also saw upside employment and Consumer Price Index surprises. The employment data look particularly important. NatWest Markets Economics preferred measure of labour market health, Pay As You Earn PAYE data, present a very different outlook to slowing gross domestic product growth stats. If the PAYE employment data continue to be strong, it could have the potential to impact the UK outlook and bring forward the BoE rate hikes, which could lend support to Sterling and will need to be watched. On the Covid front, the UK reported 54,674 new coronavirus cases on Saturday, the biggest one-day increase since January, but the UK is on track to reopen the economy today. Despite the possibility of another wave of infections, the key Covid metrics still appear positive. The success or failure of the UK’s decision to remove restrictions this week looks set to be an important driver of Sterling in coming weeks. The impact on activities due to rising self-isolation required by the NHS could be a risk to watch.

The UK economic data calendar is relatively light this week, the highlight of which will be the ‘flash’ Purchasing Managers’ Index (PMI) surveys for July. The PMI surveys appear to have turned. But the PMIs remain at elevated levels – signalling that growth rates remain above trend as the economy claws back lost ground – but the pace of improvement is now easing. This in turn serves as a key marker-post in the economic normalisation process and may even serve to nuance some of the recent recovery and reflation narrative.

Europe: EUR/USD fell below 1.18 amid dollar strength, European Central Bank in focus

EUR/USD fell below 1.18 amid dollar strength and wider risk-off market sentiment. European Central Bank (ECB) board member Isabel Schnabel argued last week that the Governing Council will take its time before tightening monetary policy to ensure price developments are entrenched despite the fact that euro-area inflation might be closer to meeting the central bank’s target than some anticipated.

The June ECB press conference leaned dovishly and the completion of the strategy review this month opens up risk of action this week. With a Fed tapering of asset purchases in the US (i.e. a reduction in the pace of quantitative easing) likely this year, the ECB will likely use Thursday’s meeting to emphasise that it is on a different course from the Fed. Strengthened guidance around the confidence on inflation, and guidance on asset purchases well beyond March 2022 will need to be watched.

Meanwhile, Covid-19 cases in Europe have started to turn higher, especially in Spain and Portugal. Lockdown decisions are looming and looking to have started in some places. Vaccinations are relatively high and rising, but that may not be enough to stave off fresh lockdowns given the Euro area has arguably taken a more cautious approach to tackling outbreaks compared to the US and the UK. The central bank’s accommodative policy stance, along with a more cautious Covid policy, will likely weigh on the EUR, in my view.

United States: USD stronger amid risk-off sentiment

The dollar ended last week stronger against the EUR and Sterling. Further overshoots in inflation in the US last week, lent some support to the dollar at the start of the week. But the USD pared some of earlier gains after Federal Reserve Chairman Powell suggested that the tapering threshold is a “long way off”, which had a dovish feel to it. Another risk-off session towards the end of last week increased the demand for safe-haven assets and supported the USD amid recent rises in Covid-19 cases and fresh restrictions (particularly in nations where vaccination rates are low).

The upcoming week is light on economic data, with a few housing-related indicators and Flash PMIs due at the end of the week. The housing data are likely to be mixed, with housing starts likely to be down after rising in May, while the Markit PMIs are likely to remain close to all-time highs. On the politics front, more noises around Biden’s proposed budget will need to be watched.

Central banks: Watching the European, South African, Indonesian and Russian central banks

The Bank of Canada delivered a reduction of asset purchases last Wednesday, but the lack of a guidance shift on rate hikes left the decision less Canadian Dollar supportive. The Bank of Korea was hawkish in last Thursday’s meeting, where one member voted for 25bps hike. Recent Covid resurgence alongside lagging vaccination rates in South Korea and the rest of Asia doesn’t seem to have concerned the central bank. Governor Lee said that from August the board will discuss the potential to raise rates. Meetings for the rest of the year are now live, but the timing of the first hike remains uncertain and will need to be watched. The Central Bank of the Republic of Turkey kept policy rates unchanged last week. The reducing likelihood for a rate cut, given higher inflation expectations, might have lent support to the currency.

This week, there are numerous central bank meetings due. On Thursday the ECB (discussed above), South African Reserve Bank (SARB) and Bank Indonesia (BI) all meet. The SARB will likely keep policy settings unchanged. While the economic outlook is more balanced, inflation risks remain to the upside. Recent bouts of widespread social unrest shouldn’t factor into the SARB’s decision right now, though they will likely be watchful of potential broader economic effects as the weeks progress. BI might also hold rates unchanged. Inflation remains very low, which will be one less factor for BI’s concern. Downside risks to domestic economic activity and growth (and downside implications for rates) are counterbalanced by a weak currency outlook for Southeast Asia more broadly (with upside implications for rates), with a serious Covid outbreak fuelling the outlook for both. BI’s Governor Warjiyo has flagged the eventual need for policy normalisation, though the scope for this could be next year. On Friday, there is the Central Bank of Russia (CBR) meeting. The CBR will likely hike rates by 50bp, as inflation pressures continue to mount and their research department commented that they have yet to see a peak in inflation.

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