The pound rallied by just under a percent last week versus the dollar as markets priced in 15bp of tightening by the Bank of England by the December 2021 meeting with a further 75bp expected next year. This led to cable being at it’s highest since the start of October which has taken the markets by surprise given the pounds expected poor performance against stagflation. Versus the euro, the pound reached an 18-month high as the single currency fails to get any help from the ECB. On the data front, unemployment came out as expected at 4.5% which was a slight improvement of the previous reading of 4.6% but given the record number of vacancies in the UK economy it was a surprise it wasn’t lower.
Sterling starts the week strongly with further hawkish comments from the Andrew Bailey on Sunday. Speaking to the Group of 30 which is an international body of economic and financial leaders. Bailey said the recent jump in inflation would be temporary, but a surge in energy prices would push it higher and make its climb last longer. He went on to say “Monetary policy cannot solve supply-side problems – but it will have to act and must do so if we see a risk, particularly to medium-term inflation and to medium-term inflation expectations.” The high impact data for the pound comes on Wednesday and Friday this week with CPI for September and Markit Services PMI for October respectively. CPI is expected at 3.2% which will match the precious reading but any higher than this the BoE may need to have a to do more to control inflation.
The dollar started to struggle last week as it gave up some of its recent gains. Though this is said to be caused by profit taking on dollar positions as markets now fully price in the start of Fed tapering by year-end and the first hike in September/November 2022. US CPI came out as expected on Wednesday at 4%, which is twice the Fed’s growth target. Jerome Powell was favoured to continue as the Fed Chairman, but his odds have recently taken a dip following sharp criticism of his performance by progressive Democrats and a trading scandal among Federal Reserve officials. A change in leadership at this point was apply extra risk on the dollar and may reverse its recent gains.
Inflation will continue to be the main driver in the FX markets this week. New Zealand has become the latest country to publish inflation figures way above anything expected. The 3Q21 figure of 4.9% YoY compared to a range of expectations from 3.8% to 4.5%. This similar to the situation in the US where back in June the market barely saw Fed Funds at 1.00% over a three-year horizon. It now sees it at 1.40%. But crucially that is still below the latest set of Fed Dots which sees the policy rate at 1.80% in 2024. The main data release of the dollar is on Wednesday this week with the release of the Fed’s Beige Book which gives a picture of the overall US economic growth and will go into further detail of how rising inflation is affecting the US businesses.
There were several ECB speakers last week with the majority being strongly dovish expect for the Dutch Governor Klaas Knot, who lived up to his reputation of being a Hawk and argued against an overly relaxed stance towards inflation, which may prove more persistent than expected in his view. However, markets remain highly reluctant to take the view that the more robust dovish front within the ECB will budge anytime soon. Accordingly, EUR/USD remains almost solely driven by dollar dynamics and the lack of any clear idiosyncratic upside catalyst for the euro is likely limiting the pair’s upside.
The ECB is the odd one out when it comes to monetary normalisation story compared to the Bank of England and the Fed. The low risk that the ECB switches to the hawkish camp keeps the EUR as one of the preferred funding currencies for carry trade and may give it some support through demand moving forward. It’s a quiet week for the euro on the data front, with the only high impact data coming on Friday with Markit PMI Composite for October. This shows the current health of the manufacturing and services sector in the eurozone as a whole, with a reading above 50 showing an increase and below 50 a contraction.
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