Risk in the UK
2022 has begun on nearly the same footing as the 2021 footprints suggested, with large looming risks in healthcare and energy, unresolved Brexit constraints, and a potential leadership change in Number 10. The government appears to be preparing for a shift in Covid policy that reduces isolation periods from seven days to five days and eventually scraps them altogether. The Prime Minister is under pressure to axe all Covid measures by the end of January, or he could face a Tory revolt.
Liz Truss, who took over Brexit negotiations from David Frost in late 2021, is preparing to override parts of the post-Brexit Northern Ireland agreement unless negotiations with the European Union prove fruitful. This is another indication that little progress has been made on this key issue, likely holding back an agreement on financial services equivalence which, in turn, has been responsible for a whole shift in trading to the continent. (Today's Big Read from The Financial Times tackles this topic in detail.)
Yet another issue worth noting is that following the collapse of several UK energy providers, high energy prices are placing additional strain on the UK’s hospitality sector, which was already reeling from Covid-related closures and lost revenues. It seems unlikely that further business relief measures will be introduced as the UK government has already warned that its ability to shield consumers from the energy crisis is limited.
Bottom line: Despite this catalogue of domestic risks, the Pound trade-weighted index is approaching three-and-a-half-year highs due to the inflation pressures which are driving Bank of England rate expectations. On net, a rate hike and unwinding of asset purchases is likely to result in higher costs for both business and consumers due to the higher cost of financing and deleveraging. While the US Dollar Index is similarly at high levels, the reflexive strengthening of the Greenback, if one of the various geopolitical risks manifests (e.g., Russian-Ukrainian War), means GBP/USD is looking pretty attractive on a relative basis.
The week ahead
Sterling has had a strong start to 2022, with the Pound Index currently trading at its highest level since October last year. Short exposures on GBP futures have been falling over the last two weeks. This comes as traders reassess the implications of both monetary policy normalisation by the Bank of England and abating Omicron fears. Traders remain net short GBP on the whole, which could fuel further moves higher in the currency as short-covers increase. Yields on UK Gilts have continued to rise across the board, with the two, five, and 10-year all reaching levels last seen in January 2019, as markets bet on more interest rate hikes by the BoE.
- The British Retail Consortium Retail Sales Monitor y/y is expected to come in at 0.3% for December versus a 1.8% reading in November.
- Monetary Policy Committee members Jon Cunliffe and Catherine Mann are due to speak this week.
- Gross Domestic Product m/m for November looks likely to have gained 0.4% following a 0.1% improvement in October.
- Industrial and Manufacturing production m/m for November will be released this Friday. Forecasts suggest that both will read 0.2% after coming in at -0.6% and 0.0% in October, respectively.
The Euro moved higher after the release of disappointing jobs data out of the United States on Friday, which pushed EUR/USD up 0.5%. Analysts at Scotiabank expect the pair to weaken to the $1.10 level as a dovish European Central Bank and a hawkish Federal Reserve continue to hamper any sustained upside momentum. The next meeting of the ECB is due to take place on the 3rd of February, with the central bank now under pressure to update its forward guidance following a 5.0% jump in consumer prices in December. There were more Coronavirus protests in Brussels over the weekend as calls to abolish the Covid Certificate intensified.
- The Euro Area Unemployment Rate came in at 7.2% for November, following a 7.3% reading for October.
- Industrial Production m/m in the Eurozone is expected to rise 0.6% in November after seeing a 1.1% gain in October.
- The latest Economic Bulletin from the European Central Bank will be published this Thursday.
- European Central Bank President Christine Lagarde speaks at the Conference of Parliamentary Committees for Union Affairs this Friday.
It was a rather frustrating first week of 2022 for the US Dollar; the index gained impressively on Monday but finished with little show for it on Friday following a rather flat Non-Farm Payrolls report. However, with the Federal Reserve the most hawkish it’s been throughout the pandemic and more dovish policy in Europe, the Dollar may be in a position to strengthen. The latest Consumer Price Index print due this Wednesday could help reinforce this monetary policy normalisation with analysts and Goldman Sachs expecting four rate hikes this year and a reduction of the central bank’s balance sheet to commence in July. Elsewhere, thousands of flights in the US were cancelled over the weekend as Omicron continues to disrupt staffing.
- Federal Reserve Chairman Jerome Powell is due to testify on his renomination before the Senate Banking Committee tomorrow.
- US Consumer Price Index and Core CPI m/m for December will be released on Wednesday. Forecasts indicate readings of 0.4% and 0.5%, respectively, to follow prints of 0.8% and 0.5% previously.
- Producer Price Index m/m for December is expected to read 0.4%, showing a slower gain compared to the 0.8% figure for November.
- Retail and Core Retail Sales m/m for December are predicted to come in at 0.0% and 0.2%, respectively, versus a dual print of 0.3% in November.
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