13.01.23: UK Economic Debate and Global Risk Trends will Dominate Near-Term Sterling moves against the Euro the Dollar
The latest US inflation data has sparked further optimism that domestic and global inflation pressures have peaked.
There is, therefore, also further optimism that global central banks will be able to adopt a less aggressive stance.
In this environment, positive risk appetite has tended to dominate global markets and lower gas prices have provided further ammunition for global bulls.
Stronger risk appetite will curb dollar demand on defensive grounds and there will be stronger expectations of a peak in Fed rates.
Overall, there will be further expectations that the fundamentals factors which triggered strong dollar gains during 2022 are no longer valid.
Markets have, however, priced in a substantial shift which will maintain the threat of profit taking and a correction.
Given these conflicting pressures, overall volatility is likely to remain elevated as dollar bulls and bears engage in further combat.
The Pound to Dollar (GBP/USD) exchange rate posted 4-week highs at 1.2240 in immediate response to the US inflation data, but was then subjected to a very sharp retreat to 1.2100.
Another strong rally and rebound to above 1.2200 also faded with the pair just above 1.2200 on Friday after better than expected UK GDP data.
As far as the domestic economy is concerned, Bank of England MPC member Mann maintained a hawkish stance with comments that underlying inflation looks pretty robust.
She expects that rates will need to increase further and there is no risk of over-tightening at present.
The Pound struggled to gain any significant support from the rhetoric with other MPC members likely to be less hawkish.
There are also further reservations over the housing sector and a slide in disposable incomes which will undermine the economy.
Lower energy prices will provide net relief for the UK economy and risk appetite is likely to remain firm after the US inflation data.
There will be further concerns that solid risk conditions and 4-year highs for the FTSE 100 index have not provided stronger backing for the Pound.
Nevertheless, there is scope for a slight shift in sentiment towards the economy and GBP/USD should be resilient with scope for a test of resistance above 1.2250 amid the fragile dollar.
There were no major Euro-Zone developments on Thursday with global developments dominating.
The Euro gained further net support from lower gas prices which traded around 14-month lows and will provide important relief for the Euro-Zone economy.
There are also expectations that the ECB will be more aggressive than most other global central banks during the first half of 2023 which provided net Euro support.
Overall, the Euro to Dollar (EUR/USD) exchange rate was hit by high volatility after the US inflation data and posted fresh 7-month highs at 1.0865 before a limited correction and traded around 1.0850 on Friday.
According to Socgen; “The euro is a buy on dips and the dollar a sell on rallies, barring new geopolitical developments.”
The bank continues to note the importance of the Ukraine war. It adds; “If the impact of the war doesn’t increase (or go away completely), our rates forecasts justify another 4 figures or so of gains for EUR/USD this year (consistent with our EUR/USD 1.12 end-year forecast).
It also sees little economic justification for a fresh EUR/USD slide to parity on economic grounds.
US consumer prices declined 0.1% for December compared with expectations of no change while the year-on-year inflation rate declined to 6.5% from 7.1%. This was in line with expectations and the lowest reading since late 2021. Gasoline prices fell sharply on the month and also posted a slight net decline on the year.
Underlying prices increased 0.3% on the month with the year-on-year rate declining to 5.7% from 6.0% which was in line with consensus forecasts.
The data maintained expectations that inflation was on a downward path and that the Federal Reserve would be able to take a less aggressive stance.
There are strong expectations that the Fed will slow the pace of rate hikes with a 25 basis-point hike at the early-February meeting.
There was very choppy trading after the data, but the dollar posted further net losses with the currency index at fresh 7-month lows. The dollar to yen (USD/JPY) exchange rate also slumped to 7-month lows below 128.20.
Overall the US currency is likely to remain on the defensive in the short term with further volatile trading.
The Japanese yen posted strong gains after the US inflation data with lower US bond yields a key element.
The yen was also resilient despite Bank of Japan bond buying.
The Pound to yen (GBP/JPY) exchange rate posted sharp losses to 1-week lows below 157.00.
In contrast, the Swiss franc remained under pressure with further net losses as demand for defensive assets faded.
The Pound to Swiss franc (GBP/CHF) exchange rate strengthened to 3-week highs around 1.1360.
The Australian dollar was underpinned by hopes for a rebound in the global economy and firm commodity prices.
The Pound to Australian dollar (GBP/AUD) exchange rate dipped further to 8-week lows at 1.7500.
The Canadian dollar struggled to respond to higher oil prices with the Pound to Canadian dollar (GBP/CAD) exchange rate posting 1-week highs at 1.6360 before fading.
The Swedish krona remained vulnerable in global markets with further concerns over the housing sector. The Pound to Krona (GBP/SEK) exchange rate posted 2-month highs just below 12.80 before settling round 12.72.
There is an important US data release on Friday with the University of Michigan consumer confidence index.
The main focus will be on inflation expectations data with further relief if the decline in headline inflation has triggered a net decline in expectations.
Reaction to the US inflation data and Federal Reserve comments will also be monitored closely.
Trends in equities will continue to have an important impact on exchange rates.
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Tim Clayton
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