FX outlook: Parky’s quick take – 20 December 2021

21 December 2021

Neil ParkerFX Markets Strategist

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Neil Parker, our FX Markets Strategist, shares his views on the currency markets this week

United Kingdom: Bank of England’s surprise hike does leave a lasting impression on GBP

Last week’s Bank of England (BoE) meeting was widely, but not unanimously, expected to leave interest rates unchanged. However, the markets were less convinced than the consensus of economists, and they were proven right to be sceptical. The BoE voted 8-1 in favour of raising the interest rate from 0.1% to 0.25%, the first hike in over three years. The change in sentiment was driven largely by the rise in inflation rates, which was seen as increasing wage demands and inflation expectations.

The Bank acknowledged that the decision was a close call, which suggests that future decisions will be driven by how the data evolves. The economic environment has been made potentially more challenging by the increase in COVID infections, prompted by the Omicron variant. As the UK government steps-up its booster programme of vaccinations, they are locked in a race against time to try to reduce the numbers of hospitalisations or deaths occurring from the new and existing variants in circulation. Consequently, the UK’s economic revival could be interrupted, risk appetite could take a turn for the worse and central banks, including the BoE, may be forced to pause in any tightening cycle.

Meanwhile, the data and surveys from last week painted a mixed/confused picture. Labour market activity slowed a little (employment growth was down from recent rates), but unemployment continued to fall, vacancies continued to rise, and the rate of average earnings growth remained higher than expected. Consumer price inflation topped 5% on a headline basis, another multi-year high, and retail sales volumes rebounded in November, though notably this was led by a surge in online sales, which once again accounted for more than 3 in 10 of all retail transactions, according to the Office for National Statistics. The Purchasing Managers’ Index (PMI) surveys were disappointing however, the preliminary readings showing that the pace of growth in both manufacturing and services had dropped in December, and by a far larger degree in services. The concerns are that this loss of momentum will continue into 2022.

For this week there aren’t any interesting releases or events due. The focus of attention will be on whether there are any additional restrictions introduced by the UK government and what effects these will have on the retail and services sectors. In the absence of any serious additional restrictions on UK businesses, the GBP might just be about able to cling on to current levels. However, the risks are likely to the downside against the USD and EUR as we head into the end of the year.

United States: Federal Reserve ups the pace of asset purchase tapering; will confidence continue to improve?

Last week’s Federal Reserve meeting and monetary policy decision followed market sentiment closely. The Fed increased the pace of the asset purchase taper to $30bn per month, although noted that it would keep a close eye on developments around the new, more transmissible Omicron variant of COVID. The new dot plots from the Fed, which detail the expected path of interest rates for all Fed members, pointed to three tightenings in 2022 and a further three in 2023, which would take the upper band of the targeted Fed funds rate to 1.75% by the end of 2023.

Meanwhile, the data was a mixed bag last week both ahead of, and following, the Fed decision. The producer prices data for November reported a further increase in the headline and core rates of producer price inflation, and the December Empire manufacturing survey rose unexpectedly. Retail sales rose much less in November versus consensus forecasts, the December Philly Fed business outlook index fell sharply, and industrial production rose marginally less than expected in November. The preliminary December PMIs for manufacturing and services reported a drop in both, the former to the lowest reading seen since Dec-20.

This week does not have a huge amount of important data due, but there will be interest in the final Q3 GDP, December consumer confidence, November existing and new home sales and November personal income and spending figures due for release. Unless there is a materially different outturn to what is expected, it is likely that the markets will remain in a state of risk aversion, which will mean equities under pressure, yields lower and the USD benefiting from safe haven flows. The only currency that the USD is having trouble making headway against is the Chinese yuan, but then again, the recovery in the Chinese economy has been more impressive than that of the US.

Europe: ECB looking for signs of inflation pressures easing from early in 2022; confidence still on the decline

The European Central Bank’s (ECB) meeting last week recorded that some members of the Governing Council are uneasy with the direction of monetary policy, but they continue to be overruled by many on the Executive Board who are more concerned about the underlying weakness of the economy versus the short-term inflation spikes driven by supply chain disruption. The ECB remains inclined to leave monetary policy ultra-loose throughout 2022, with the first increases in interest rates likely to come in H2 2023.

Last week’s data and surveys appeared to provide validation to that strategy. Industrial production rebounded in October, but the sector remains subdued in terms of activity because of supply chain and labour shortages. There were further declines in the manufacturing and services PMIs in the preliminary December releases, and there was another sharp drop in new car registrations across much of Europe. Meanwhile, the consumer price inflation figures for Euroland continue to indicate that core inflation pressures remain under more control than in the UK or US. The German IFO business climate index for December continued to fall, and Germany could see its economy shrink in Q4, according to reports from the Bundesbank.

This week sees no really important releases due, but watch for confidence readings from Belgium, Italy and Finland throughout the week. They may also record a drop in confidence as COVID infection levels remain elevated or are increasing. There are other issues surrounding the Euroland recovery. The increase in restrictions in Europe could prompt a collapse in activity in other economies, with countries such as Austria adopting severe restrictions on movement for the unvaccinated. Will this force the European governments to provide additional fiscal support, or will they hope the latest COVID outbreak will prove less severe and less of a strain on healthcare resources?

For the euro, there is some hope that the economy may rebound quickly, but the EUR continues to underperform versus the likes of the USD and the GBP. It would appear logical to expect that underperformance to remain as we tick off the final few days of 2021. Whilst the euro has made very little headway this year, having made a promising start, as we approach the end of the year, the hope will be that 2022 sees more lasting strength for both the Euroland economy and the euro. The fundamental headwinds to growth in Euroland in 2022 may be less severe than those affecting the UK and US, which may provide that lasting upside.

Central Banks: a host of hikes last week with Mexico surprising; Thailand and Czech Republic in this week’s spotlight

Last week began with a 125 basis point hike from the central bank of Chile, which was followed by no change from the central banks of the Philippines, Indonesia and Switzerland. The Norges Bank though raised rates to 0.5%, in line with forecasts, and then the markets held their breath to see what the Turkish Central Bank would do. It cut interest rates by 1 percentage point to 14%, and though the central bank said the room for additional loosening had disappeared, the markets had already lost all confidence, the Turkish lira losing over 18% of its value from where it opened last week. The final spate of central bank meetings towards the end of the week saw Banxico raise Mexican interest rates 50 basis points (only 25bps was priced in), the Bank of Japan leave policy on hold, the Russian central bank hike 100 basis points to 8.5% and the Colombian central bank hike by 50bps to 3%.

The concerns of central bankers around inflation are that they are worried about it leaking into inflation expectations and wage settlements. That may be further exacerbated by worker absences and businesses hiking prices. However, if these rate increases start to undermine activity and investment, then many of these emerging and developing economies could find themselves back in recession. This is a fine balancing act between credibility, something that the Turkish central bank has lost, and maintaining recovery.

For this week, the Bank of Thailand is set to leave interest rates on hold at 0.5%, whilst the Czech central bank is set to raise interest rates to 3.5% from 2.75%. The inflation risks that currently hold sway may be put to one side in the near term if the Omicron variant continues to grow rapidly across a number of continents. That could yet prompt a pause in the monetary tightening that dominates continents like South America.

View last week’s Quick Take.

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