Central bank talk provides some clarity for currencies

​​​​​​Today's news headlines:

  • 'Fed Chairman Powell now sees current interest rate level just below neutral’. US monetary policy close to the point where the economy will neither grow or contract. (CNBC)
  • ‘Bank of England says no-deal Brexit would be worse than 2008 crisis’. Unemployment would hit 7.5%, while inflation could reach 6.5%. (The Guardian)
  • ‘Romania minister calls for curbs on EU free movement’. Brain drain is causing a labour shortage in one of Europe’s poorest countries. (Financial Times)

Wednesday’s session saw two potentially pivotal statements from central bankers, which in turn, provided some valuable clarity for the market. The Bank of England’s (BoE) assessment of the damaging effects on the UK economy from a no-deal Brexit could arguably have been predicted, but to have some idea of that possible scale of any slowdown may once again help focus the minds of politicians as they enter a critical phase of the debate. Across the Atlantic, Federal Reserve Chief Jerome Powell provided some insight as to the pace of US interest rate hikes in the New Year. His statement that rates are now just below neutral means that the economy only has limited capacity to absorb further policy tightening before growth risks being stubbed out. The DXY Dollar index posted some meaningful losses as a result, with the Dollar’s run of gains through 2018 potentially now having run out of steam.

German Unemployment data is set to be released at 8.55am GMT, and the market is expecting no significant change from the October figure. However, there are growing signs that the Eurozone economy as a whole is slowing. If this slowdown manifests itself with a material impact for today’s reading, then it could be sufficient to once again call into question the European Central Bank’s (ECB) ambitions to normalise its monetary policy. Anything that stands to push back the timing of the first proposed rate hike later next year would serve to weigh on the common currency.

There is also inflation data scheduled for release from Germany at 1pm GMT which could prove telling. The ECB needs to target a level just below 2.0%, and the reading is fully expected to come in above that level. The big risk, however, is that the rate of descent is too rapid, inferring that the print will undershoot the target early in the New Year—a situation that would inevitably be exaggerated by the prospect of interest rates increasing.

The Personal Consumption Expenditure Deflator is expected to be published in the US at 1.30pm GMT, and this reading is acknowledged as the Federal Reserve’s preferred measure of inflation. With this in mind, too marked an increase would put Jerome Powell’s recent stance at odds with the data, and as a result, could see some recovery of yesterday’s losses by the US Dollar. Donald Trump may be rallying for a less aggressive monetary policy, but the bottom line is that the Federal Reserve’s remit is primarily one of keeping inflation in check.

It’s a quiet day for the UK economic calendar, although the Brexit narrative will once again have the potential to drive sentiment. Any further clues as to whether lawmakers will be willing to pass the Brexit bill at the first reading could prove instrumental. Britain is now exactly four months away from the March 29th deadline, so if Theresa May can start striking some side deals to galvanise support, then the Pound may actually find something worth cheering.

GBP/USD

Yesterday’s dovish tone from the head of the Federal Reserve was sufficient to give the Pound a sustainable boost against the US Dollar. However, extending the rally in the face of Brexit uncertainty may prove rather more challenging.

EUR/USD

Jerome Powell’s words delivered meaningful support to the Euro against the US Dollar during Wednesday’s session, with the common currency rallying by more than a cent as a result. However, rising German unemployment or suggestions that US inflation is still running too hot could quickly see this move reversed.

GBP/EUR

The Pound managed to break out to two-week highs against the common currency yesterday, but this proved to be short-lived. Despite the potential need for European Union reform, the UK’s woes regarding Brexit are evidently rather more pressing.