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Data in focus before policy decisions next week

Dollar to slide for second successive month? Eurozone inflation eyed before ECB; resilient sterling could be at risk.

George Vessey, UK FX & Macro Strategist

Dollar to slide for second successive month?

The US dollar snapped a five-week losing streak against a basket of currencies following better-than-expected flash PMIs released on Friday. Resilient private sector activity supported a rise in the probability of a 25-basis point Federal Reserve (Fed) rate hike next week to 90% from under 70%. Still, the dollar is on track for a second straight monthly loss as markets are still pricing Fed rate cuts before year-end.

Despite the composite PMI in expansion territory for a third month in a row, economic activity appears to be cooling and inflationary pressures in the US are easing. Volatility in equities, bonds and FX markets has also reduced over the past month, which has weighed on the safe haven US dollar. This week will be another busy week in terms of macro data with the first estimate of first-quarter GDP and the Fed’s preferred measure of inflation, the PCE price index, taking central stage. Meanwhile, the US earnings season will also kick into a higher gear as several big names are set to report. The banking sector turmoil, which rattled markets last month, has cooled substantially, helping to boost global risk appetite, which has supported the circa 4% depreciation of the dollar against a basket of currencies over the past seven weeks.

Rate differentials continue to be a key driver of FX trends though, and if it transpires that the market pricing of Fed rate cuts is too aggressive, the dollar may be primed for a rebound if the Fed pushes back against this pricing next week. EUR/USD continues to struggle to break and hold above the key $1.10 level for now.

What recession? PMIs surprise higher. S&P Global, composite purchasing manager index (PMI - 50).

Eurozone inflation eyed before ECB

Markets are expecting the European Central Bank (ECB), which also meets next week, to raise rates by 25-basis points, but the chance of a 50-basis point hike also stands at 30%. Like the US, the flash PMI prints last Friday revealed more evidence of robust business activity, reducing concerns about an impending recession. The euro remains range-bound, but is over 5% above its 1-year average rate against the dollar.

ECB President Christine Lagarde said last week that inflation in the Eurozone remains too high and the ECB’s monetary policy “still has a bit of way to go” to bring back inflation towards its 2% goal. The focus this week will be on the provisional inflation reports from various EU countries, which will probably reveal inflation in Germany and France eased further to a 13-month low and a 7-month low, respectively. Flash first-quarter GDP results will also drop in, but more attention may be on the more forward-looking Eurozone business sentiment surveys and Germany’s Ifo and GfK business climate reports, which have rebounded strongly of late. EUR/USD has had a strong positive correlation with this “soft” data over the past few months as our soft data proxy indicates, although narrowing interest rate differentials remains a key driver of EUR/USD upside traction.

Ultimately, despite the data influx, the proximity to the key central bank meetings implies a more cautious approach may be taken by traders, and we may not witness much in the way of FX volatility until after the Fed and ECB meetings. The trading range for EUR/USD could therefore potentially remain between $1.09-$1.10 this week.

Expectations have rebounded in line with EUR/USD rise. German soft economic data proxy and EUR/USD.

Resilient sterling could be at risk

The British pound remains one of the best-performing currencies of 2023 so far, bolstered by a revival in risk appetite amidst fading systemic risk fears and as investors position for the end of the global tightening cycle in the second half of this year. However, greater resilience in recent UK data has supported the notion of more rate hikes by the Bank of England (BoE), which is also promoting demand for the pound.

Last week we saw a surprise pickup in UK wage growth followed by above-expectations inflation figures. The March report showed headline inflation decelerating from 10.4% to 10.1%, with the core rate holding steady at 6.2%, whilst food prices continue to rally. The services sector, which makes up most of UK economic activity, continues to outperform and services inflation, which makes up over 60% of the UK consumer price index, continues to prove sticky. Retail sales remains in negative territory, but we did see a rebound in consumer confidence amidst a more positive view of finances and the health of the wider economy. As a result of mostly upside macro surprises, the BoE is expected to hike in May, but markets are pricing a further two more hikes, which would take the BoE’s terminal rate to 5%.

Should this pricing prove too aggressive, the pound could be subject to a sell-off though, and with speculators flipping to their first net-GBP long position (more bets on GBP appreciating than depreciating) since February last year, this provides more scope for a revaluation of sterling lower, potentially. GBP/USD is holding onto $1.24 and GBP/EUR onto €1.13 for the time being and the former is 3% higher than its 1-year average, whilst the latter is 2% below its 1-year average.

No wonder markets think BoE will have to hike more...Economic vs inflation surprise (latest readings).

FX volatility eases ahead of CB decisions

Table: 7-day currency trends and trading ranges

7-day currency trends and trading ranges.

Key global risk events

Calendar: Apr 24-28

Key global risk events calendar.

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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.

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