Out of kilter
Global supply chain issues are set to impact both UK and EU third-quarter earnings, but neither central bank is in a particular rush to raise interest rates. This is logical given that supply-driven inflation exerts downward pressure on economic growth, but money markets in the UK have a different idea. According to Bloomberg, economists have revised down the UK growth estimate for 2022 by 0.4%, making the market’s rate expectations even more unsupportable.
The market has priced in a 25-basis-point hike for December, another for February, and a third for May 2022. Given that no rate hike is likely until May next year and growth is being revised down, this seems optimistic beyond rationality. Sterling has been keeping pace with the US Dollar, which is also trading towards the top of its trade-weighted range, naturally drawing a comparison between their respective economic positions. Last week, we explained how the UK’s reliance on energy imports—oil continues to make fresh gains this week—will have a detrimental impact on its pace of expansion, while the US is a modest net exporter of energy and will be less affected.
Bottom line: All in all, the Pound’s position seems vulnerable to a reversal if interest rate markets recognize the cognitive dissonance of their bets. In that case, the most likely beneficiary might be the EU; it's not in a dissimilar position to the UK but has been trading towards the bottom of its respective trade-weighted range. Don’t get us wrong, the European Central Bank isn’t in a position to cut stimulus, but then, neither is the Bank of England in a position to raise rates. We’d argue that the BoE should trim its asset purchases, but it has set interest rate hikes as a prerequisite for that monetary policy adjustment.
The week ahead
Last week, Sterling had its best performing week since February 2021 on a trade-weighted basis, climbing 0.8% against its peers and reaching 20-month highs against the Euro. Sterling has rallied with UK government bond yields as traders continue to increase bets of an interest rate hike as early as December this year, despite recent data releases suggesting a slowdown in the UK’s economic recovery. On Sunday, Bank of England Governor Andrew Bailey reiterated ‘we will have to act’ to control inflation, warning that the energy crisis risks extending and accelerating the inflation trajectory. Bailey will be speaking again on Tuesday afternoon, in addition to other Monetary Policy Committee members throughout the week.
- Wednesday’s Consumer Price Index reading is expected to see the price level rising 3.2% year-on-year to September, with the Core CPI reading expected to be 3.0% for the same period.
- Retail Sales data released on Friday for September is predicted to show a bounce-back, growing 0.6% compared to August’s contractionary -0.9%.
- Friday’s Markit Purchasing Managers’ Index readings are expected to indicate expansion—although at a slower pace than in August—across Manufacturing and Services sectors, at 56.0 and 54.5, respectively.
The Euro’s recent decline took a breather last week, bouncing back 0.23% on a trade-weighted basis after posting year-to-date lows against the Greenback early in the week. Over the weekend, European Central Bank President Christine Lagarde reiterated the central bank is ‘committed to preserving favourable financing conditions’ and that ‘inflation is largely transitory’. This is rhetoric that the market is already familiar with and which reinforces the diverging stances of the ECB and other major central banks. This divergence has helped lift GBP/EUR by almost 3.00% this month as investors anticipate earlier rate hikes from the Bank of England.
- Wednesday’s Eurozone CPI figure is forecasting 3.40% growth in prices in the year to September, up from 3.00% in August.
- On Thursday, the Eurozone Consumer Confidence survey is anticipated to read at -5.0 for the month of October, down from -4.0 last month.
- Friday’s Markit PMI readings are expected to show expansion in both the manufacturing and services sectors at 57.1 and 55.4, respectively.
The US Dollar ended a five-week run of gains on a trade-weighted basis last week as its index ran into technical headwind at its 100 and 200 daily moving average. Momentum in the Dollar’s rally has stagnated, despite last week’s higher-than-expected inflation figure and markets bringing expectations of an interest rate hike forward to September 2021. What’s more, Wednesday’s release of the Federal Reserve’s latest meeting minutes showed agreement among policymakers to begin tapering asset purchases in mid-November or mid-December as long as the economic recovery stays strong. Thursday’s labour market data and Friday’s PMIs could create more momentum for the US Dollar to extend its year-to-date highs, along with several Fed members who are speaking throughout the week.
- Monday’s Industrial Production for September is projected to show slowing growth at 0.2% versus 0.4% in August.
- On Thursday, Initial Jobless Claims data is expected to come in slightly higher than last week’s 293k reading, at 300k.
- It’s anticipated that Friday’s Markit PMI figures for October will show expansion in the manufacturing sector at 60.5 and services sector at 55.2.
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