FX outlook: Parky’s quick take – 25 October 2021

26 October 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: Sterling holds, government budget eyed

GBP/USD grinded higher to levels around 1.38 before paring some gains towards the end of last week. The UK inflation data turned out broadly in line with economists’ expectations in September, with consumer price inflation (CPI) edging down slightly to 3.1% from 3.2% prior (vs Bloomberg survey consensus expectation 3.2%). Retail sales showed a drop of 0.2% in September, well below economists’ forecast of a rise of 0.6% (Bloomberg survey). The consecutive 5-month fall in retail sales could signal a slowdown of momentum in economic recovery. Perhaps some of this will be temporary, as consumers diverted spending during the summer and early autumn to leisure services rather than retail, but the soft retail sales data still hints at a possible fragility in the UK consumer demand. On the other hand, composite Purchasing Managers’ Index (PMI) turned out much stronger than market expectation (Bloomberg): 56.8 in Oct from 54.9 in Sep (54.0 expected). This was driven by a big rebound in services (58.0 from 55.4) but also a rise in manufacturing sector (57.7 from 57.1). The pick-up in composite PMI will likely point to an improvement in GDP growth in Q3 and Q4. It will be interesting to see if the central bank chooses to push back on the recent rise in rate tightening expectations given today’s mixed economic data (25 Oct).

The UK’s data calendar this week is fairly quiet, and the focus might turn to the government budget this Wednesday. The Chancellor, Rishi Sunak, will likely stick to a disciplined approach against a backdrop of surging inflation and expectations of higher interest rates, in my view.

EUROPE: EUR pares gains after soft German IFO data, ECB in focus

EUR/USD edged higher to levels around 1.1650 last week before paring the gain on Monday. The region’s October preliminary PMI data turned out to be mixed. Manufacturing PMI remained resilient (58.5 vs Bloomberg survey consensus 57.1), while services PMI fell to 54.7 from 56.4, slightly below economists’ expectation of 55.4. Composite PMI also showed a drop to 54.3 from 56.2 (vs consensus 55.2). The survey data suggest a modest slowdown at the start of Q4 after a buoyant Q3. Germany appears to be leading the region’s slowdown, with its composite PMI falling to 52.0 from 55.5 (vs consensus 54.3). The soaring energy prices and supply chain issues might have partially contributed to the slowdown. Monday morning’s German IFO survey showed another drop to 97.7 in October from 98.9 prior, slightly lower than economists’ expectation of 98.0 in a Bloomberg survey. This suggests that supply issues continued to have a negative impact on the manufacturing sector, and the normalisation in the services sector seems to be losing steam. 

The European Central Bank (ECB) will meet on Thursday and will likely continue to play down risks to recent rising inflation and reiterate its accommodative monetary policy stance. Market investors are expecting a rapid path of cutting asset purchases, which appears inconsistent with the central bank’s forward guidance. The ECB will likely use this meeting to push against this, as Chief Economist Philip R. Lane did recently, in my view.

UNITED STATES: Dollar modestly lower, Q3 GDP eyed

The USD traded slightly lower against the EUR and GBP last week amid improving market sentiment and falling short-term US government bond interest rates. Last Friday’s manufacturing PMI slipped to a six-month low of 59.2 (vs Bloomberg survey consensus 60.5) in early October from 60.7 in September. In contrast, the services counterpart rebounded to 58.2 (vs consensus 55.2) from a nine-month low of 54.9 in September. Supply side bottlenecks continued to be a common theme for both measures, as suppliers’ deliveries times within the manufacturing survey and orders backlogs within the service survey each climbed to all-time highs.

The Q3 GDP report comes under the spotlight this week and will likely show a pause after a robust gain in Q2. On the Fed front, the Fed officially enters its blackout period (a policy which limits the extent to which policy makers speak publicly or grant interviews) from Monday, so we won’t be hearing from any more policy makers until the meeting. But the Fed appears on track to announce cutting asset purchases in their November meeting and the focus seems to be shifting to the timing of the first rate hike, which could be the main driver of the dollar, in my view.

Central Banks: A multiple of central banks decisions

Emerging Market (EM) central banks seem to be increasing their tightening pace. The National Bank of Hungary hiked rates by 0.15%, consistent with economists’ expectation in a Bloomberg survey. Their tightening cycle will likely continue until their inflation stabilises, according to the central bank’s post-meeting comments. Similarly, the Central Bank of Russia (CBR) hiked rates by 0.75% amid upside risks to inflation. This was above market expectation (Bloomberg) of 0.25%. Turkey, however, was an outlier. The Central Bank of the Republic of Turkey (CBRT) cut policy rate by 2% last Thursday despite the deteriorating inflation outlook. The collapse of credibility in the country’s monetary policy framework, the prospect of further de-anchored inflation and dollarization due to lira depreciation pushed lira to fresh all-time lows.

Similar to most of their EM peers, Brazil and Colombia appear on track to raise policy rates this week amid deteriorating inflation. The ECB (discussed above) and the Bank of Japan (BoJ) are among the dovish camp, which will likely keep their monetary policy settings unchanged and maintain their accommodative policy stance. Japan’s low trend inflation implies that a reopening of the economy might not trigger the spike in wages and inflation seen in other advanced nations, thus it might be too early for the BoJ to take action now. The Bank of Canada (BoC) will meet this Wednesday. They have reduced their bond purchase programmes at each of the past two meetings with a Monetary Policy Report (MPR). This pattern will likely continue in its October meeting, which includes a fresh MPR. Given the high headline inflation, improving growth, ultra-high home prices and surging energy prices, whether there will be a more hawkish guidance change at the October meeting (such as, guidance suggesting a rate hike could be appropriate in the first half of 2022) will need to be watched.

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