The calm after the storm

US rate hikes are back on the table for March, while the UK budget unlikely to be game-changing for pound.

George Vessey, UK FX & Macro Strategist

Yesterday’s US inflation data received less attention than during previous months as the question regarding the financial stability in the US continued to overshadow any impact of short-term economic data releases on markets.

However, the rise in core inflation by 0.5% for the month of February (5.5% year-on-year) was still able to pull the probability of a rate increase by the Federal Reserve (Fed) in March back above 50%. The disinflationary forces – goods inflation and services inflation, excluding shelter decreasing, will only start impacting monetary policy after the March meeting. So, while we do expect the Fed to raise its benchmark interest rate by 25 basis points next week, the stress in the banking sector and the accompanied tightening of financial conditions will make it harder for policymakers to continue the tightening cycle beyond May.  

The US dollar is currently stuck between two opposing forces. The negative re-pricing of US interest rate expectations and the steepening of the yield curve have weighed on US currency, but higher bond volatility (12-year high) and depressed risk sentiment have limited the dollar’s losses. After recording three consecutive days of gains., EUR/USD has met some resistance at $1.0750 following the CPI release. Now, focus shifts to US retail sales as the next potential catalyst.

Budget unlikely to be game-changing for pound

UK Chancellor, Jeremy Hunt, will present his first spring Budget today amidst a somewhat brighter outlook for both the economy and public finances. The Office for Budget Responsibility is likely to revise higher its short-term GDP growth forecasts and reveal public borrowing remains high, but much lower than anticipated. The Budget is not usually a market-moving event (barring last September’s turmoil when GBP/USD fell to a record low) but is certainly one to keep an eye on.

The most pressing issues facing the UK finance minister are high inflation, weak growth, strikes and labour shortages. Whilst the UK is the only G7 advanced economy not to have returned to its pre-pandemic level of output, economic activity has been stronger than previously forecast. In terms of public finances, gas prices dropping 80% since last August have brought down the cost of the Energy Price Guarantee and tax revenues have held up amidst a resilient labour market. Thus, Mr Hunt has been handed a £30bn windfall according to the Office for National Statistics, so there is scope to provide extra support for energy bills, keep fuel taxes down and potentially solve public sector strikes. Key for companies will be the amount of money Mr Hunt spends to encourage business investment, which has stagnated since the Brexit vote. Corporation tax rises from 19% to 25% in April, but a three-year investment tax break worth about £11bn has been rumoured. For more information ahead of the Budget, the Financial Times has published: Five things to look out for.

GBP/USD has snapped back from 1-month highs above $1.22 as stress in financial markets has calmed, but the currency pair’s 50-day moving average appears to have flipped from resistance to support. Against the euro, the pound has also recoiled about 0.6% from the €1.14 handle – lacking any directional conviction. We doubt the Budget today will spur a meaningful positive or negative reaction in the pound, but amidst speculation the Bank of England is close to pausing rate hikes, the euro could reclaim recent losses, especially if the ECB leans more hawkish tomorrow.

Europe following the lead

The week has started off without any significant economic data releases in Europe. European investors have therefore closely followed events in the US – assessing the contagion risk from the failure of the Silicon Valley and Signature banks.

Despite the global bond and stock sell-off spreading to Europe as well, the euro’s resilience suggests that markets have interpreted the US banking failures as isolated events. The 2-year German Bund is once again closing in on the 3% mark, after falling from 3.38% to 2.45% in just four trading sessions. Following the US CPI print yesterday, markets are once again pricing a 50-basis point hike by the European Central Bank (ECB) as a done deal, suggesting that the ECB will stay the course in its tightening cycle with projections likely showing inflation above 2% throughout 2025. The mood in EUR/USD today may be subdued ahead of the ECB’s meeting tomorrow.

Today’s market movers will once again be US dominated with retail sales, producer price inflation, the empire manufacturing index and home builders’ housing index all coming up. The release of Eurozone industrial production will be watched as well, with a slight rebound in January (+0.2%) expected following a weak December (-1.7%).

GBP 2% higher than USD compared to last Wednesday

Table: 7-day currency trends and trading ranges

Key global risk events

Calendar: Mar 13 -Mar 17

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