With the Bank of England’s next interest rate decision only due to be announced next week, and nothing in the data calendar of note, today looks likely to be a quiet day for sterling. Yesterday’s trading did see some movement, with the pound falling 0.2% against the dollar and just under 0.5% against the euro, as UK markets got back to work following the bank holiday weekend. This price action was largely driven by events elsewhere, however, with eurozone inflation and US banking concerns top of mind for traders. Financial stability concerns in particular appear to be having some pass through, with market expectations for the BoE’s terminal rate being pared significantly since the end of last week. OIS implied probabilities now suggest that roughly 2.5 further hikes can be expected, down from almost three last Friday, as markets consider both the viability and desirability of further rate hiking in the context of slow growth and bank stability concerns. Whilst this brings markets more closely in line with our view, that the BoE will hike one more time before conditionally pausing rate hikes, we expect that impact on the pound of trimming expectations is likely to be increasingly muted, as markets begin to move focus away from the immediate Bank Rate outlook and towards on the longer run growth and rates environment in the economy.
The big week for policy makers is set to continue in the eurozone tomorrow, with an ECB meeting just now around the corner and a rate decision expected to land at 13:15 BST. As such, yesterday’s CPI release was the final data point before policy makers have to sit down and decide on their next move to tackle inflation, which was actually seen ticking up on the headline measure, from 6.9% to 7.0%. Markets and policy makers might take some more comfort however from the core numbers, which showed price growth slowing to 5.6%, down from 5.7% and suggesting that on this measure at least the peak might be in. Nevertheless, markets see tomorrow’s rate decision as close to a foregone conclusion, with 25bp of hiking all but guaranteed. The key question will be around the future path for rates, with OIS pricing suggesting that traders currently foresee roughly two further hikes beyond the upcoming meeting before the ECB hits its terminal interest rate. In our view, comments from ECB President Lagarde shortly after the interest rate decision is announced will be pivotal for markets. Whilst we agree with markets in anticipating a further 50bp of hikes following tomorrow’s meeting, it seems likely that the ECB will retain a data dependent bias. For FX markets, a hawkish tone and suggestions that the ECB will keep rates higher for longer are likely to provide support for the euro. In contrast, a hint towards an early pivot on growth or financial stability concerns may see a retreat of the euro from its current near YTD highs.
A very busy week for financial markets will continue today with the latest interest rate decision from the Federal Reserve due to be revealed at 19:00 BST. Markets and economists, including ourselves, are looking for a final 25 bp hike to terminal from the Fed, with guidance from chair Powell after the announcement on the path forwards for US rates likely to be pivotal for price action in markets. It seems unlikely at this point that the FOMC will take the possibility of future rate hikes off the table, and in our view will signal a higher for longer path in line with their dot plot. Given current market expectations that foresee cuts to interest rates as soon as September, this would be more hawkish than currently anticipated and would suggest modest upwards support for the dollar. However, the backdrop for this latest announcement is the fall of yet another regional US bank, and concerns around the debt ceiling coming to the fore. Whilst the takeover of First Republic Bank of JP Morgan over the weekend led to less disruption in markets than the failure of SVB, its demise has reignited concerns over the US banking sector and the impact of higher interest rates, with the KRE index of regional bank stocks falling over 6% in yesterday’s session. In addition, comments by Treasury Secretary Janet Yellen continue to weigh heavy, with an ominous projection that the US debt ceiling might bind as soon as June 1st, much sooner than previously expected. Whilst news did break yesterday that speaker McCarthy has agreed to meet with Biden on May 9th, this has done little to quell concerns, and the dollar fell around 0.25% against the euro over the course of a choppy session as these concerns bubbled to the surface. It was into this mix that JOLTS job opening data, a measure that has been highlighted by Chair Powell, dropped yesterday afternoon. Falling once again, and managing to undershoot expectations by around 150k by coming in at 9590k, this points once again to a slowing US job market. In our view, this will make the decision for the Fed to pause rate hikes after this latest meeting somewhat easier, but we do not think that the totality of current conditions is sufficient to steer away from one final hike, although this is a tail risk to our forecast. For the dollar, the tone of Chair Powell’s press conference is likely to be crucial. A hawkish 25 bp and a conditional pause, in our view the most likely outcome, is likely to offer some greenback support. But signs of tightening credit conditions driven by financial stability or political concerns are risks that, if highlighted, would pose dollar downside risk.
The loonie took another battering yesterday, as banking concerns south of the border and a falling oil price weighted once again on the currency. USDCAD rose almost six tenths over the course of the day, with markets continuing to digest concerns around the stability of US regional banks, but it was the fall in WTI that again provided a downwards impetus for the loonie. With nothing in today’s data calendar, all eyes will be on the Federal reserve, where a final 25bp hike to terminal is expected. With the BoC currently on hold, markets will be looking for guidance on the path for US rates, and given current market pricing it seems possible that suggestions of higher for longer could produce yet another leg up in USDCAD later today.