Stubborn UK inflation fuels rate-hike bets
At last, an end to seven consecutive months of double-digit inflation in the UK. However, for the third month running, figures have surprised on the upside, particularly in core inflation, raising the chances of more interest rate hikes by the Bank of England (BoE) and supporting demand for the pound. GBP/EUR is stretching north of €1.15, scaling a five-month peak, whilst GBP/USD climbs back towards $1.25 having dipped below $1.24 (a one-month low) yesterday.
Britain’s year-on-year inflation rate slowed to 8.7% in April from 10.1% in March, however, the BoE expected a drop to 8.4% whilst most economists had forecast a drop to 8.2%. Meanwhile, gauges measuring services and core prices accelerated at the fastest pace in more than three decades. This was a crucial set of figures, hotly anticipated by the BoE and investors, and given the surge in core inflation from 6.2% to 6.8%, it now seems all-but certain that the BoE will raise interest rates from 4.50% to 4.75% in June. Digging deeper into the report, we see that food price inflation remained close to 45-year peaks, and removing energy components, core prices accelerated to a new cycle high.
The pound is trending higher solely because interest rate expectations for the UK have increased as a result, providing the UK currency with greater yield appeal relative to its peers. Investors quickly moved to price in the BoE raising the key rate almost a full percentage point above 5.25% before year-end.
Dollar steady amid haven demand and hawkish signals
The US dollar hit a two-month high against a basket of currencies yesterday as Treasury yields rose following hawkish comments from Federal Reserve (Fed) officials as well as data signalling the fastest pace of expansion in the US private sector since April 2022. The debt ceiling remains a key short-term risk, boosting safe haven dollar demand too.
The market shift toward pricing in rate cuts this year was precipitated by the March banking turmoil, but despite recent stability and signs that this won’t morph into a crisis, markets are still pricing in rate cuts by the Fed before year-end. However, as we’ve seen recently, rate-cut bets may continue to recede with turmoil subsiding and a higher-for-longer rate regime as a result, should support short to medium term dollar strength. Regional Fed Presidents James Bullard and Neel Kashkari indicated earlier this week that the Fed may need to continue hiking rates if inflation remains high. Yesterday’s flash PMI prints revealed service sector growth accelerated to a 13-month high, helped by stronger demand conditions, which in turn, may keep services inflation elevated for longer – supporting the Fed’s hawkish narrative and the dollar’s ascent.
What if debt ceiling negotiations fail though? Treasury yields are likely to fall as the risks to the economy spur a flight-to-safety, which may also boost USD demand. However, curve steepening would also likely accelerate in that scenario, as the economic risks cause the Fed to ease monetary policy, which could hurt the dollar further out. For now, EUR/USD sags under the $1.08 level, nearly 3% off its 2023 high as the US-Eurozone rate differential continues to widen.
Euro becoming numb to hawkish ECB speak
The slowdown of the reopening effect in China and the prolonged interest rate increases have taken a toll on the German manufacturing sector. The services sector, on the other side, has accelerated in recent months. The discrepancy between the two highlights the difficulty of setting policy against the background of diverging economic trends.
The German purchasing manager index grew for the fourth consecutive month, helped by the rapid expansion of the services sector. While the deterioration of the manufacturing index from 44.5 to 42.9 was not enough to drag the composite index into negative territory, it did cement the idea of a weakening global demand for German goods. This comes just days after the release of new orders and industrial production showing declines for the month of March. The PMIs painted the same picture for the broader Eurozone economy, where the manufacturing gauge fell to a 36-month low of 44.6.
This data point in isolation will do little to steer the European Central Bank (ECB) off its rate hiking path. According to Bundesbank President Joachim Nagel, more tightening will be necessary to bring inflation under control. The German policymaker suggested raising and then maintaining rates at restrictive levels, which would go against markets pricing in rate cuts as soon as Q2 2024. The euro’s sensitivity to ECB speak has definitely weakened against the backdrop of the macro deterioration. EUR/USD continues to trade lower and has fallen well below the $1.08 mark.
GBP/JPY up 3.5% in seven days
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: May 22-26
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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.
