Neil Parker, our FX Markets Strategist, shares his views on the currency markets this week
United Kingdom: Bank of England Chief Economist Pill and Governor Bailey signal rate hike isn’t a slam dunk
Last week saw a whole raft of data and survey releases from the UK that suggested the economy was experiencing ongoing strength, as well as heightened inflation pressures. The labour market data recorded ongoing strength in employment and PAYE payrolls data, with a larger than expected fall in the unemployment rate in September (dropping to 4.3% from 4.5%). Consumer price inflation data for October recorded jumps in the headline and core rates to decade highs, and then the markets waited for November consumer confidence and October retail sales figures. Both performed admirably in the latest releases, with confidence bouncing back, although not all the way back to the September reading, with retail sales volumes rebounding in October after stagnation in September.
So, the markets will have viewed the news in aggregate as a positive, enhancing the case for a rate rise at the December Monetary Policy Committee meeting, and a positive for forecasts regarding 2022 rate rises. There was a spanner thrown into the works of market expectations at the end of the week, which saw yields drop sharply and GBP sell-off following a couple of sessions of gains against the USD.
Chief Economist at the Bank of England (BoE), Huw Pill, cast doubt on the need for the central bank to raise interest rates, noting that the decision would be “finely balanced”, stating there’s “no quick fix” to bring inflation back to the 2% target, and noting that the central bank doesn’t have the tools to fix supply chains. It will be tricky for the BoE to vote in favour of a rate increase if the Chief Economist doesn't vote for it, and his comments will resonate with businesses facing short-term cost/price increases. His comments were then cemented by BoE Governor Bailey, who in a Sunday Times interview argued that the economic risks were two-dimensional.
For this week, there is fairly little noteworthy data or survey releases due from the UK. There will be interest in the provisional November Chartered Institute of Purchasing and Supply manufacturing and services Purchasing Managers’ Index (PMI) data, due on Tuesday. Will these PMIs report ongoing strength or some signals of weakness in activity as we head towards the end of the year? The pound may continue to underperform against the USD, and there will be a lot of interest to see whether GBP/EUR can build on recent gains. The risks are for some GBP weakness after Pill’s comments, in my view.
United States: US data surprises unable to maintain market momentum
The US economy remains in reasonable health. There wasn’t a huge amount of data released last week, but strong October retail sales and industrial production figures further cemented expectations in the markets that the Federal Reserve would complete the asset purchase taper before the end of H1 2022 and be in a position to raise interest rates before the end of 2022. That release came after the Empire manufacturing survey for November, which reported a sharp improvement in the index, but also noted longer lead times for inputs and higher prices being paid. Over the remainder of the week, there was weakness in the housing starts data for October, but a sharp improvement in the Philly Fed business outlook reading for November.
Chicago Fed President Evans then stepped forward to also cast doubt on the confidence that markets were showing regarding the need for monetary tightening before the end of 2022. He stated that he felt inflation by the end of 2022 would be a lot closer to 2% than many people thought, and also that the case for a hike in US interest rates was not obvious. Evans’ comments are a reminder that central bankers were, until recently, talking about the transitory nature of inflation and some clearly still think that the supply chain disruption will disappear relatively quickly.
President Biden’s latest piece of fiscal spending and tax reform passed the House of Representatives last Friday. However, the bill, worth around $2 trillion, will face greater difficulty in the US Senate and may still require lengthy debate and possible alteration in order to pass. Even so, the US authorities continue to press ahead with significant fiscal spending, which could create a further headache at the Federal Reserve. Biden’s pick for Federal Reserve Chair is apparently due imminently and could undermine market sentiment dependent on who is chosen.
For this week, there will be some interest in the existing home sales data for October, provisional November PMIs for manufacturing and services and the jobless claims figures for the latest week. However, with the week shortened because of the Thanksgiving Day holiday most attention will remain on revised Q3 Gross Domestic Product (GDP) figures, the final November University of Michigan consumer sentiment survey and the minutes of the November Federal Open Market Committee meeting. These latter releases are due on Wednesday, ahead of the holiday and could undermine further the case for accelerating the Fed taper and any early hike in US official rates. For the USD, the data is unlikely to upset recent momentum.
Europe: EUR underperforms as data disappoints and ECB remains calm
There were few important Euroland data and survey releases last week. But the data recorded an improvement in Q3 Euroland employment, with a rise of 0.9% on Q2, whilst the Q3 GDP growth figure was confirmed at 2.2% in the latest estimate. Euroland headline inflation was 4.1% year-on-year, but the core inflation rate was revised down to 2% from an initial reading of 2.1%. The inflation figures were a notable departure from the significant overshoots seen from other developed economies lately.
Comments from various members of the European Central Bank’s (ECB) Governing Council also offered calm amidst a clamour for higher interest rates across many developed economies’ financial markets. The most noteworthy of the speakers was ECB President Christine Lagarde, who stressed that the ECB shouldn’t tighten too soon despite the painful headline inflation figures being recorded. She also stressed that the prospects for medium-term inflation were better now than pre-pandemic – when the ECB had frequently struggled to lift inflation back to target. Those comments contrasted with Bundesbank President Jens Weidmann, who argued that inflation may remain above target in the medium term, suggesting he is more hawkish on monetary policy than many in the ECB.
The EUR continued to underperform against other major currencies last week. It fell to fresh 16-month lows against the USD and 18-month lows against the GBP (in EUR/GBP terms). Currently, there appears to be little that can support a significant recovery in the EUR, especially with some countries across Europe re-introducing restrictions or lockdown measures as Covid infections soar (see Austria). The risk of another setback to the recovery in Euroland, driven by increased Covid infections could lead to further EUR underperformance in the weeks to come, in my view.
This week’s key releases are the provisional November Euroland PMIs for manufacturing and services and the November German business climate survey from IFO (Information and Forschung, Germany’s Institute for Economic Research). These surveys could record some improvement, similar to the improvement seen in the Sentix investor confidence index and the German surveys from ZEW (Zentrum für Europäische Wirtschaftsforschung / Germany’s sentiment index) already released. That though may only stem the EUR’s underperformance, rather than turn things around.
Central banks: Turkey demonstrates what happens when politics interferes; New Zealand and South Korea to hike this week
Last week saw the central banks of Hungary and Iceland hike interest rates by 0.3% and 0.5% respectively, with both central banks warning of the potential damage of higher inflation. The Philippines central bank then also announced it would leave the policy rate on hold, to support growth objectives, even though inflation rates remain elevated at the moment. Towards the end of the week, the South African Reserve Bank increased interest rates by 0.25% to 3.75% – although the decision was not unanimous, supported by 3 of the 5 voting members. In the midst of this, the Turkish central bank cut interest rates from 16% to 15%. Ahead of that, President Erdogan had made it clear he wanted interest rates lowered, and having dismissed three central bank chiefs in the space of less than two years (from mid-2019 to March 2021), it was unlikely that the current central bank head, Kavcioglu, was going to dissent. The market response was emphatic, the lira weakening to fresh lows, as fears grew regarding Turkey abandoning its commitment to keep inflation under control. Could Turkey be heading back to the bad old days of devaluation and hyperinflation?
This week is a less busy affair in terms of central bank meetings. The central banks of Israel and Sweden are expected to leave interest rates on hold when they meet on Monday and Thursday respectively, but sandwiched in the middle is the Reserve Bank of New Zealand (RBNZ) meeting (Wednesday), and closing out the week is central bank of South Korea meeting (Thursday). The RBNZ are expected to raise interest rates for the second time in as many meetings, from 0.5% to 0.75%. Elevated inflation expectations and concerns over unemployment at a record low are likely key to the RBNZ’s decision making. The South Korean central bank are also expected to hike rates to 1% from 0.75%, with inflation rising to levels well above target. Overall though, in my opinion, there is less chance of any surprises from this week’s batch of central bank meetings.
View last week’s Quick Take.
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