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GBP
Sterling struggled to capitalise on yesterday’s soft US inflation print, retracing most of its rally after initially touching a fresh five month high against both the dollar and the euro. Capping the pound’s upside is general uncertainty over the future path of UK interest rates. Whilst a 25bp hike in the Bank Rate to 4.5% at today’s midday meeting is almost a foregone conclusion, the Bank’s next steps are still widely unknown. This has led to an array of forecasts for UK interest rates, with estimates of the terminal rate ranging from 4.5-5%. This puts the emphasis on today’s decision on the Bank’s forward guidance, however, we don’t expect this to be explicit given the Bank’s February forecasts have already shown quite a wide forecasting error. As such, we expect the rate statement is likely to retain language that “further tightening would be required” if there is evidence more persistent inflation pressures. Although, we note that if any edits are made to this statement that they are likely to be dovish in nature and will result in an aggressive market response. We think the Bank is aware of this, and as such they will likely be non-committal in their guidance, instead leaving market participants to read between the lines within the meeting minutes and the MPR to extract the more discrete information provided. This will largely take place within the latest round of economic projections, where the Bank is expected to update its forecast for inflation in light of stronger growth, faster momentum in price growth, yet renewed signs that inflation pressures are starting to moderate, its estimate of wage growth given higher average hourly earnings growth and signs that labour demand is cooling, and its forecast for GDP following more robust growth data and positive supply side developments. Specifically, we will be monitoring whether the BoE deems the improved growth outlook to be more inflationary or primarily driven by improving supply-side dynamics like Chief Economist Pill recently alluded to. Additionally, policymakers’ emphasis on higher headline wage growth or signs that growth in pay settlements is starting to moderate alongside cooling labour demand will be telling, especially as the Bank remains vigilant of signs that a wage-price spiral is taking hold.
On the whole, we expect the full suite of BoE materials to signal to markets that the Bank doesn’t intend to take rates higher in the coming meetings, raising the threshold for economic data to force such actions. However, this may not be perceived as dovish by markets, especially because the Bank has taken this stance for some time now and has repeatedly been forced by incoming data in tightening policy further. In the absence of a more explicit signal from Governor Bailey or by the removal of the Bank’s tightening bias in the rate statement, we think today’s BoE decision may not provide a bearish impetus for sterling. Instead, we look towards the next round of economic data released at the end of this month as the catalyst for markets to bring down the current implied terminal rate from 4.83% towards our estimate of 4.5%.
EUR
With little in the data calendar as far as market moving eurozone releases are concerned, all eyes and ears will once again be on ECB speakers, with a raft due to hit the airwaves yet again today. The theme of recent communications has been to push back on market expectations, with the implied terminal level having slipped following last week’s interest rate decision. Despite raising rates by 25bp and indicating that future hiking was close to a certainty, markets took the step down from 50bp increments as a sign that the ECB is now in the home stretch of its tightening cycle, leading to a paring of expectations for the ECB terminal rate with fewer than two more rate hikes currently priced in. The response from ECB speakers has been understandably hawkish, beginning with comments from Head of the Dutch Central Bank Klaas Knot over the weekend, who suggested that eurozone rates could go to 5% or higher. This trend was continued once again yesterday, most notably by Bank of Latvia chief Martins Kazaks, indicating that markets should not assume that ECB hiking will stop in July. While the comments by Knot and Kazaks may have fallen on deaf ears given their stature, the story of today looks set to be little different, with ECB big hitters Schnabel (13:00 BST), de Gunidos (18:30 BST) and Governor of the Banco de España de Cos (11:30 BST, 15:45 BST) set to speak. However, with OIS implied expectations for ECB hiking seemingly resistant to repricing on hawkish commentary in the absence of the data confirming such stance, it appears likely that today’s comments will once again be overlooked. As such, the impact on the euro from today’s speakers should be marginal, with events elsewhere continuing to drive price action in EURUSD which has fallen by around half a percent this morning. GBPEUR will also be one to watch today, with event risk a potential driver for the cross, given a Bank of England decision due at 12:00 BST.
USD
The dollar broadly sold-off yesterday as fixed income traders reverted to pricing in more rate cuts from the Fed this year. After falling to just 67bps following the strong jobs report on Friday, a further 8bps of cuts were put back into the December OIS contract yesterday after April’s inflation report showed signs of softness despite both the headline and core measures meeting expectations at 0.4% MoM. Specifically, the Fed’s measure of underlying inflation, the so-called “supercore” measure of inflation which is core services ex shelter, continued to moderate while the number of above-target inflation drivers narrowed as a whole. Accounting for 89% of the monthly increase in headline inflation were just three components: shelter, used cars and trucks, and gasoline. Additionally, components where inflation is driven more directly by higher wage inputs or strong discretionary spending, such as dining out and airline fares, saw prices either print flat or fall on the month. While the data doesn’t necessarily signal that the Fed needs to imminently cut rates, it certainly did signal that the Fed’s rate hike last week was likely the last of this cycle.
While the dollar traded slightly weaker yesterday afternoon and in the overnight session, the move has been retraced and then some heading into the European open this morning. It is notable that while an end to the Fed’s hiking cycle is positive for risk assets as the discount rate stabilises and the risk of recession is capped, this hasn’t necessarily transpired given lingering concerns over the US banking system and more importantly over the US government defaulting seeing as discussions on raising the debt ceiling continue to bear no fruit. With Congressional leaders set to meet again tomorrow to attempt to bridge the divide, today the dollar is likely to find support these concerns, while commentary from Kashkari and Waller is likely to follow on from Barkin’s last night by stressing that inflation remains stubbornly high despite signs of improving.
CAD
Checking the daily change in the loonie might suggest on the surface that nothing happened at all yesterday. To the contrary, intraday volatility was quite high. The main event, US inflation, broadly met expectations, while the headline index edged down to 4.9% despite economist expectations that it would hold steady at 5%. A tenth of a percentage point is hardly significant in the grand scheme of things, but the loonie rallied sharply against the dollar as traders priced out the tail risk of a Fed hike in June, and added to bets that it would cut rates by year-end. Why such a large market reaction to a minimal deviation from expectations? Simple—many traders were worried that inflation would come in hotter than economists had forecast, and positioned themselves accordingly. As the outcome the market had least expected played out, USD longs were unwound, resulting in a brief bout of robust CAD strength. But considering US inflation had not changed all that meaningfully, USD bulls who were previously on the sidelines merely viewed the USDCAD sell-off as a more favourable entry point. Throughout the remainder of the trading session, the flow of information was fairly minimal, and the loonie tracked closely with swings in US equities. Shortly after lunchtime in Toronto, however, it was clear the pendulum had swung too far in the other direction, and new CAD longs brought the currency back to flat on the day.