Dollar stays data dependent in data filled week
US inflation fell more than expected in the month of June, confirming the recent string of disinflationary data points. The Federal Reserve’s (Fed) preferred measure to track inflation, the personal consumption expenditure index, rose 0.2% last month from May with the yearly change of core inflation rising by 4.1%, the least since June 2022.
The weaker print was accompanied by the quarterly release of the employment cost index (ECI), which has recently been mentioned by Jerome Powell as being an important inflation gauge. The ECI rose by 1% in the second quarter, marking the slowest increase since 2021. However, while the recent inflation data has been encouraging, the US economy continues to perform better than expected. This has raised questions about the sustainability of getting inflation back to the Fed’s 2% target. The upcoming week will offer some gauge for how the largest economy in the world is doing.
Investors will focus their attention on the ISM manufacturing and services PMIs on Tuesday and Thursday and the labor market report published on Friday. The consensus expected job growth to have remained above 200 thousand in July, a growth rate not consistent with a sharply slowing economy. However, with most of the shock from higher interest rates still expected to come through in the next quarters, today’s release of the important SLOOS (Senior Loan Officer Opinion Survey on Bank Lending Practices) by the Fed will be watched as well.
Euro stuck between two opposing forces at $1.10
The European common currency is currently stuck between following the positive disinflationary trend in the US, pushing EUR/USD above the $1.10 mark, and being pressured by the continued weakening of economic data out of Europe. The last two weeks were a perfect example of these two forces colliding and driving FX markets.
The euro started its 10-day descent after reaching a 15-month high on the 18th of July at $1.1250 after a string of weak German data and resilient US macro releases increased the divergence between those two economies. The currency pair briefly fell below the important $1.10 mark after the dovish interest rate increase by the European Central Bank (ECB) on Thursday and speculations that both the Fed and ECB could be done tightening monetary policy. However, EUR/USD did not stay too long below the threshold as US inflation data showed price growth continued to ease in June.
Bets on a rising euro have increased in recent months on speculations that the Fed would have more room to cut rates next year, being more ahead in its fight against inflation and hopes that German macro pessimism might have peaked. While most international institutions and investment banks do not expect a sharp recovery from Europe’s largest economy, Germany has officially already exited the recession, recording a growth rate of 0% in the second quarter 2023, after having fallen in the last two quarters. Now it’s up to the incoming data to determine if this hypothesis has any legitimacy. This week’s highlights will be the release of German retail sales and Eurozone inflation on Monday, German labor market data on Tuesday, and German and French industrial data and Eurozone retail sales on Friday.
BoE to hike rates to 15-year high
Following in the footsteps of the Fed and ECB, the Bank of England (BoE) is widely expected to hike by 25 basis points this Thursday, taking UK interest rates to a fresh 15-year high of 5.25%. There is a slim risk of a larger 50-basis point hike though and UK rates volatility continues to climb because of this uncertainty. GBP/USD is back in the mid-$1.28 area this morning after bouncing off a key upward sloping trendline last week at circa $1.2760, whilst GBP/EUR is hovering just shy of the €1.17 mark.
Although there is still a high degree of uncertainty about the BoE’s reaction function, the welcome news on UK inflation a few weeks back has taken a fair amount of pressure off the UK central bank to repeat the 50-basis point rate hike it implemented in June. Services inflation, which the BoE is most concerned with, unexpectedly dipped back in June’s data, and was complimented by better news in other areas, including food. The better-than-expected news on inflation was tempered by a recent upside surprise to pay growth, but that was offset by further signs of cooling in the jobs market and an ongoing return of workers. The economy seems to be responding slowly to the swift surge in rates though. Economic growth has held up better than expected, and recession risks in 2023 have sharply receded. In short, there seems to be enough in the latest data flow for the BoE to revert to a 25-basis point hike this week, but we cannot rule out another jumbo hike which could result in a knee jerk boost to sterling. The vote split, additional forward guidance and updated economic projections will also be important points to watch.
The pound remains one of the top performing currencies year-to-date, up over 6% against the US dollar and on average nearly 9% higher against our world’s currencies basket. This is largely thanks to 1. Improved global risk sentiment and 2. Rate-hike expectations. It is mainly the latter that’s creating a high bar for further sterling gains should the BoE underdeliver.
GBP/EUR rises over 1% on widening yield spreads
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: July 31- August 4
Have a question? [email protected]
*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.
