What’s happening with currencies this week? Neil Parker, Market Strategist shares his views.
United Kingdom: Risks of negative UK interest rates recede further
Last week’s big UK economic releases were threefold. First released were the consumer prices data for December, on Wednesday. These reported a rebound in headline and core inflation rates, such that the prospects of negative interest rates from the Bank of England were further priced out by the markets, and the pound rallied. There are few signs that the inflation environment is worsening, or has worsened, which would be a potential trigger for a rate cut to below zero.
Secondly, UK retail sales for December reported a sharp reduction in the pace of annual sales growth, but volumes rose in December on a month on month basis. Whilst the data were worse than expected, the effect on FX markets was limited. Of greater concern was the third and final release, provisional January PMIs (Purchasing Managers’ Index) for manufacturing and services. The PMIs declined more sharply than expected, with the manufacturing expansion much slower in January than in December, perhaps as the need for stockpiling abated, whilst services activity shrank at its fastest pace since May 2020. The market reaction was again minimal to this news, but being worse than expected, it demonstrated that the UK authorities still have their work cut out to deliver a strong and sustained upturn.
The COVID vaccine rollout continued strongly, with the vaccine numbers rising sharply from just under 4.6m vaccinations (first and second dose) as at the end of 17th January, to more than 6.8m by the 23rd January (with the Sunday totals still to be released). The UK government has stated that they intend to have offered the top four priority groups vaccinations by 15th February, and although that still looks to be a tight deadline, the most recent vaccination figures suggest it will be achieved. The rates of infection do now seem to be consistently falling, and as such the pressure on the NHS (National Health Service) may start to alleviate in the coming weeks.
For this week, the attention is likely to be on the labour market data for November/December. The unemployment rate is expected to have climbed to 5.1% from 4.9% in October, and employment is expected to have declined by over 100k, according to consensus forecasts. With the markets expecting things to be fairly bad regardless, the pound is unlikely to be under much additional pressure from this release. The January update of the IMF’s (International Monetary Fund) World Economic Outlook might be more interesting, in terms of how the growth numbers for 2020 and 2021 have changed with the re-introduction of lockdowns in Europe, and tighter restrictions in the US. How will the UK’s economic position have changed versus that of its neighbours and competitors, and will this alter GBP valuations?
United States: New US President gets to work; Fed to stay steady
Joe Biden was inaugurated as the 46th President of the United States on Wednesday. With restrictions widespread across the US, and heightened concerns of a repeat of violence seen a week prior when protestors invaded the Capitol Building, the ceremony was low key, and most of the surrounding area locked down. The President swiftly got to work, signing a raft of executive orders to support the COVID response and reverse the measures enacted by his predecessor, Donald Trump, on climate change. His Treasury Secretary nominee, Janet Yellen, was already hard at work in front of Senators, attempting to sell them on an additional, COVID driven, fiscal stimulus bill worth $1.9 trillion. That will be the focus for this administration in the early days, along with looking to rebuild diplomatic and trade ties with other major economies, and trying to get on top of the COVID outbreak, via restrictions and vaccinations.
The data and surveys from the US economy were sparse last week. Those that were released recorded strength in the housing market in December, from housing starts to existing home sales, but the NAHB (National Association of Home Builders) housing market survey for January recorded another pull back, which may translate into weaker activity and demand over the next few months. The US provisional January PMI readings for manufacturing and services were better than expected, the manufacturing reading hitting its highest since the series began, and the services reading bouncing back to levels of activity similar to those in October and November. This did little to help the USD, which closed out the week just shy of 1% lower on a trade weighted basis.
This week’s big event is the Federal Reserve’s monetary policy meeting. The decision on Wednesday is widely expected to be no change to policy, but the questions over recovery, and also the timing of any further loosening or, eventually, tightening remain. The Federal Reserve will, no doubt, welcome the additional fiscal loosening proposed by the new President, as it relieves the pressure on them to loosen more. The Fed have been swift to note that any tapering of asset purchases would be well flagged, suggesting that any tapering is likely to be many months, if not quarters away. There is also the first estimate of Q4 GDP (Gross Domestic Product) released on Thursday. Could this support a USD rally? It’s is unlikely, given expectations are for modest additional GDP gains, but Q4 GDP in the US will likely contrast with renewed contractions in Euroland and the UK.
Europe: ECB (European Central Bank) leaves policy on hold as pandemic restrictions tighten
The ECB sounded marginally hawkish after their Governing Council meeting last week. The central bank argued that they would not add to bond purchases just to fill quotas. They would have been heartened by the news that the German ZEW (Zentrum für Europäische Wirtschaftsforschung / Germany’s Sentiment Index) survey for January comfortably beat expectations, and the provisional January PMI readings for manufacturing and services also beat consensus forecasts, though the composite reading underperformed. However, the ECB were quick to note that the economy faced a second contraction, driven by lockdowns, and stood ready to offer additional stimulus if required. They noted that despite their best efforts, a return of inflation back to target wasn’t feasible over the coming months, and President Christine Lagarde is increasingly being pressed over the EUR’s strength. On this latter point, the EUR is not far off its highest levels since 2018, and consumer price deflation not far of its peak in 2015. With restrictions, lockdowns and curfews likely to remain in place for many more weeks, and the European vaccination programme having gotten off to a stuttering start, the recovery is likely to be some way off, and any alleviation of deflationary forces may be even further away.
This week has seen the release of the January German IFO (Information and Forschung / Germany’s Institute for Economic Research) business climate survey. After better readings from the ZEW and PMIs, German and Euro Area respectively, it was anticipated that the IFO would follow suit. It didn’t though, with the readings slipping more than expected. The reaction in FX markets was muted, with a lockdown-related downturn already largely priced for. German consumer price inflation figures are released on Thursday. These are expected to bounce back sharply from the negative readings seen in December, as temporary tax cuts are reversed. How much will that feed back into pricing, given forced business closures and light consumer demand? There are no other significant data releases due from Euroland or its major economies this week, and any downside risks to the EUR are likely to be limited.
Central banks: Bank of Canada (BoC) hint at taper, Turkey leave rates on hold
Last week’s plethora of central bank meetings saw no change in policy from any of them. There were some surprises in the decisions however. The BoC whilst leaving policy unchanged indicated that, despite the near term contraction it was experiencing, the domestic outlook was stronger and more secure. This prompted a change in the language used, to suggest that, as the central bank becomes more confident ‘in the strength of the recovery’, bond purchases ‘will be adjusted as required’. This isn’t signalling a tightening of monetary policy, but rather than the pace of additional monetary easing will slow.
Also last week, the Turkish central bank left interest rates on hold, in line with consensus forecasts, albeit that a minority saw an additional hike as the risk. In order to allay any market fears, the central bank suggested that they would retain the tightening bias, and keep rates at current levels for an extended period. That prompted lira gains in the aftermath of the decision, although these only partially reversed some of the losses seen over the past two weeks.
For this week, there isn’t expected to be any interest rate moves from the central banks due to announce, although there is room to loosen policy in Kazakhstan, Nigeria, Colombia and Chile if required. All eyes remain on the roll out of the vaccine to coronavirus in the developed world, as this will give a signal as to the speed and scale of the recovery in these economies, and the pass through effect onto the developing/emerging world also.
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