20.01.23: UK Economic Debate Crucial for Near-Term Sterling Moves against the Euro and Dollar
There has been further hawkish rhetoric from central bank officials during the past 24 hours.
Federal Reserve members have continued to warn that further interest rate increases are needed to bring inflation down to the 2% target.
The ECB has also insisted that further rate hikes will be needed.
Markets are still sceptical that the hawkish stance will be sustainable, especially in the US.
Commentary from central banks will continue to be watched very closely in the short term.
Global economic trends will also be watched closely with traders questioning whether optimism over the outlook is justified.
Gas prices remain at lower levels and close to 16-month lows which should provide underlying support for the optimistic camp.
Markets are also forward looking and will want to focus on the potential for looser monetary policies later in 2023 and into 2024.
In this context, unless the near-term data is extremely poor, risk assets are likely to find strong support on dips.
In comments on Thursday, Bank of England Governor Bailey stated that market expectations of a 4.50% peak in interest rates are not out of line.
Bailey was also more optimistic over the inflation outlook with the potential for inflation to fall quite rapidly from late spring. The recession is expected to be relatively shallow by historic standards.
The comments overall from Bailey were relatively optimistic. The combination of a relatively hawkish policy stance and slide in inflation would also boost real interest rates which should provide Sterling support.
The Pound to Dollar (GBP/USD) strengthened to test the 1.2400 level before fading slightly.
There are also expectations that UK energy prices will decline later in the year, but there will be a tough first quarter. Consumer confidence dipped in January and there was a 1.0% slide in December retail sales, reinforcing near-term fears.
GBP/USD dipped to near 1.2350 on Friday after the UK data.
Risk conditions will continue to be important for the Pound and there will be a further conflict between short-term fears and longer-term hopes for the economy.
Overall, at this stage, there should be solid GBP/USD support on dips.
ECB Council Member Knot stated that the ECB s planning to hike rates by 50 basis points multiple times with no sign that underlying inflation is abating. Bank President Lagarde stated that inflation is way too high and that the bank will stay the course with rate hikes.
The latest minutes from the December meeting were also hawkish.
The Euro gained some support from the hawkish rhetoric, although it still struggled to gain significant traction.
The Euro to Dollar (EUR/USD) exchange rate found support below the 1.0800 level and edged higher to 1.0840 in early Europe on Friday.
Gas prices edged lower which provided on-going support for the Euro.
Socgen focussed on the importance of gas prices and the possibility of stronger Euro gains. It has a year-end EUR/USD target of 1.1200.
It notes; “If we could get our heads properly around the idea that the energy crisis is over despite the war in Ukraine rumbling on and Russian gas flows to Europe having largely dried up, we’d need to raise the forecast to around 1.20.”
It added that a removal of energy security fears would shift the market focus; “No need for a risk premium due to the fragility of gas supplies? No doubts that the global LNG market can grow in time for next winter? Take out those concerns and European recession risks melt away, leaving all the focus on the ECB.”
The Philadelphia Fed manufacturing index remained in contraction territory for January with a reading of -8.9, but this was above December’s figure of -13.7 and slightly stronger than consensus forecasts of -11.0.
Companies were slightly more optimistic over the outlook, but still notably cautious while pricing pressures are forecast to ease after mixed evidence in the January survey.
Fed Vice-Chair Brainard stated that it will take some time and resolve to get inflation down to the 2% target. She added that the slowing in rate hikes allows the Fed to assess more data as it moves policy to sufficiently restrictive levels.
There has been little net change in the Federal Reserve stance with on-going rhetoric that further interest rate increases are needed to bring inflation back to the 2% target.
Markets, however, are still sceptical that the hawkish rhetoric is sustainable given evidence of a notable slowdown in the economy.
Overall, the dollar is likely to maintain a soft underlying tone for now.
There has been further volatile yen trading during the past 24 hours with the Japanese currency losing ground again in Asian trading on Friday.
The Pound to yen (GBP/JPY) exchange rate gradually gained ground and peaked just below 160.00 before trading around 159.75.
Sterling posted gains against commodity currencies on Thursday before fading on Friday.
The Pound to Australian dollar (GBP/AUD) exchange rate posted 2023 highs just above 1.7950 before a retreat to 1.7860.
The Pound to Canadian dollar (GBP/CAD) exchange rate edged higher to 1.6690 and close to 6-week highs before a retreat to 1.6650.
The Pound to New Zealand dollar (GBP/NZD) exchange rate hit 7-week highs at 1.9400 before a retreat to 1.9290.
The Norwegian Norges Bank held interest rates at 2.75% at the policy meeting and expects that there will be rate hike at March meeting.
The Pound to Norwegian krone (GBP/NOK) exchange rate hit 6-week highs just below 12.30 before a limited correction.
The US data is unlikely to have a big impact unless there is a slide in existing home sales.
Comments from Fed members will remain under scrutiny as this is the last chance to comment ahead of the blackout period ahead of the February policy meeting which comes into force on Saturday.
There is likely to be position adjustment ahead of the weekend, especially with Chinese markets closed next week for the new-year holidays.
Equity markets will continue to have an important impact on exchange rates.
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Tim Clayton
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