News & Analysis


The fourth-largest one-month slip in the preliminary services PMI on record yesterday saw GBPUSD drop like a stone as markets began to price in a more dovish rate outlook in the UK. The May data saw the diffusion index for the service sector drop from 58.9 to 51.8, while anecdotal evidence pointed towards lower rehiring intentions and weaker consumer demand preventing firms from passing on higher operating costs. Given the Bank of England is currently concerned about high inflation, but more specifically services inflation as this is where tighter monetary policy can have an impact, and a tight labour market spurring wage growth, yesterday’s data confirmed our base case that the BoE will struggle to continue its sequential hiking cycle in the second half of the year. Broad US dollar weakness in the afternoon of the European session saw sterling trim some losses, with GBPUSD closing the day out 0.45% lower. Although the PMI data suggested that a weaker demand outlook may prevent higher continued inflation pressures from the services sector, news from the UK’s energy regulator, Ofgem, that the energy price cap is likely to rise to around £2,800, up from £1,971 currently, suggests that headline inflation will rise again in Q4 regardless. While the price cap increase isn’t certain as the reference window doesn’t close until August, the news resulted in economists temporarily raising their estimate of peak inflation in the UK to above 10%. Today, there is very little on the economic agenda from the UK, with just BoE policymaker Tenreyro speaking at 16:15 BST.


The single currency continued to rally yesterday as it was talked up by ECB policymakers. Speaking at Davos, ECB President Lagarde stated that a recession in the euro area is not the base case scenario for the central bank. Lagarde also stated in a Bloomberg TV interview with Bank of France Governor Villeroy de Galhau that monetary accommodation doesn’t need to be expeditiously removed, as she attempted to talk down calls by some ECB members for a 50bp hike at July’s meeting. On the more hawkish side, Austrian Governor Holzmann yesterday stated that “a bigger step at the start of our rate-hike cycle would make sense…anything else risks being seen as soft”. He joins his Latvian and Dutch colleagues in not ruling out a larger policy move. While Lagarde’s tone is seen as a bit more dovish now the debate shifts from the timing of the first rate hike to the magnitude, the shift in the core messaging from the central bank is still supporting the single currency. The more explicit forward guidance comes amid a backdrop of slowing manufacturing output, as highlighted by yesterday’s preliminary PMIs out of the eurozone, while the service sector continues to expand as reopening tailwinds persist. Today, the theme of growth and monetary policy remains for EUR traders. At 07:00 BST, the final reading of Germany’s Q1 GDP confirmed that the economy expanded just 0.2% QoQ in the first quarter. Meanwhile, later today, a string of ECB policymakers will hit the wires. This includes hawkish members Holzmann (08:40 BST) and Knot (10:45 BST) along with prominent Governing Council members Lagarde (09:00 BST) and Lane (10:45).


The US dollar was trading broadly stronger against the G10, with the exception of JPY and EUR, ahead of yesterday’s data releases. However, the combination of a slowdown in the flash services PMI from 55.6 to 53.5 in May and weaker-than-expected new home sales data for April increased concerns over the US economy’s growth profile and the hawkish Fed pricing in assets. In response to the data, the dollar tumbled across the board, with the largest move occurring against the yield sensitive JPY, equities extended losses, and US yields were led lower by the front-end of the curve (-13bp on the 2-year). Further confirming the dovish repricing in markets, Atlanta Fed President, Raphael Bostic, doubled down on his dovish comments from Monday in an essay on the regional bank’s website, where he urged his colleagues to move “with intention and without recklessness,” a comment that could be aimed, in part, at taming the recent volatility in cross-asset financial markets. Bostic likened the Fed’s tightening path to that of a fire engine attending an emergency and stated that it still stops at crossroads so as to not cause further accidents along the way. Bostic’s comments reiterate his messages earlier this week where he called for a pause in the hiking cycle at September’s meeting in order to assess the passthrough of previous actions. Today, monetary policy remains the focal point for markets as the Fed’s May meeting minutes are released at 19:00 BST.


The loonie weakened by four-tenths of a percent on Tuesday despite no releases of Canadian economic data. Yesterday’s CAD price action was largely the result of a deterioration in the US growth profile being priced into US financial assets. That spilt over into a swift repricing of the Canadian exchange rate because of the high degree of economic integration between the US and Canada. The afternoon rally in the TSX, Canada’s main equity index, went counter to the decline in the US-based S&P 500, which likely helped the loonie retrace some of its losses. Further support for CAD likely came from the improving interest rate spread, as yields on front-end Canadian bonds fell substantially less than US Treasuries yesterday. Today, the data calendar remains sparse in Canada yet again, while the loonie continues to trade on a weaker footing after slipping slightly overnight.

FX Elsewhere – monetary policy still matters

The Kiwi dollar is the standout performer in the G10 space overnight, sitting half a percentage point higher against both USD and AUD following another 50bp hike by the Reserve Bank of New Zealand. While the hike to 2% was widely expected by markets, the move was coupled with hawkish forward guidance such that financial conditions tightened further. In their latest forecasts, the RBNZ signalled that the cash rate would peak at 3.95% in Q3 2023, up from a peak of 3.35% in 2024 in the February forecasts. The more hawkish projections led fixed income traders to price in higher rates into interest rate instruments, with the yield on the 2-year note rising 12bps to 3.25%. On the other end of the spectrum, however, the Turkish lira is back in the spotlight as it weakens to the lowest level since December 2021’s crash. The combination of rising inflation, higher inflation expectations, static monetary policy that is keeping real rates deep in negative territory, and external financing pressures, is starting to bite for currency traders. Although policymakers have shown increased appetite for a weaker lira in the past year, the recent depreciation still increases the risk of capital controls being tightened.



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