Lagarde has convinced investors of a July hike
The European Central Bank continued its fight against inflation, raising its benchmark interest rates for the eight consecutive time. The deposit rate has now reached the highest level since 2001 at 3.5%, surpassing the peak reached before the Global Financial Crisis. Markets continue to see another rate hike in July as the base case with core inflation remaining elevated.
The ECB’s forecasts have been a topic of discussion during the press conference given the revisions that have taken place in March and in June. The growth picture has remained fairly unchanged, with the central bank’s economist’s forecasting GDP growth of 0.9% (vs. 1%) and 1.5% (vs. 1.6%) for 2023 and 2024 respectively. However, the second consecutive upward revision of core inflation by 50 basis points from 4.6% to 5.1% for this year and from 2.5% to 3% for next year has raised some eyebrows about the political signaling effect the ECB might have been going for. Christine Lagarde confirmed the Governing Council’s dissatisfaction with still elevated core inflation rates and has hinted at raising rates again in July. Markets are pricing in between one and two rate hikes (40 basis points), meaning that a hike in September is still not out of question (80% probability).
Nonetheless, given the fact that the ECB’s projections have been completed at the end of May and the recent data stream painting us a picture of broad disinflation in Europe, risks of overtightening have grown since the last meeting. Falling headline inflation and broader price pressures in the form of import, producer and wholesale inflation trending into negative territory should impact core inflation rates with a lag. The hawkish press conference and hints about another rate hike in July were enough for rates to reprice higher. German two-year government bond yields rose the third day in a row to 3.18%, reaching the highest level since early March. EUR/USD followed suit and crossed the $1.0950 mark for the first time since May, on track to record the largest weekly jump since November 2022.
Mixed data leaves another Fed hike on the table
The first patch of US macro data following the rate decision by the Federal Reserve has been mixed. While retail sales unexpectedly rose in May, signaling continued resilience of the consumer in line with the latest labor market report, industrial production and initial jobless claims surprised to the downside. Market pricing remained fairly unchanged following the data releases with investors placing a 70% probability of a Fed hike taking place in July, which would conclude the tightening cycle.
Retail sales increased (0.3%) for a second month in a row with 10 out of 13 retail categories advancing last month and beating almost every estimate in the Bloomberg’s economist survey. Optimism about the data point has been dampened by industrial production slipping by 0.2% in May, the first negative print in five months. Weekly initial jobless claims increases as well, rising from 245 thousand to 262 thousand in the week ending June 10, reaching the highest level since late 2021. We continue to see the labor market as softer than it appears as first leading indicators are starting to turn. This has been enough for the Fed to pause its tightening cycle in June but further weakness will be necessary for policy makers to step down from their calls of hiking in July. Incoming data will continue to be of high importance.
The US dollar fell in yesterday’s trading following the rate hike and hawkish press conference from Christine Lagarde. Swap differentials have been moving against the Euro since early April based on the dovish repricing of the ECB following weaker than expected inflation prints. However, this week’s divergence between a cutting PBoC, pausing Fed and hiking ECB has been enough to breathe some life into the euro and pound, both rising substantially versus the dollar and yuan on the week.
The pound benefiting from monetary divergence
The pound continues to profit from its inflation profile and market expectations of continued policy tightening by the Bank of England. Traders are taking advantage of this singular factor driving FX right now as monetary divergences start to become visible. While the Fed and ECB are still expected to raise interest rates in July, the BoE is the only central bank out of these three, that is expected to have a higher benchmark interest rate in two years than now.
This assumption has catapulted GBP/USD to its highest level since April 2022, having risen by 23% since September to $1.28. The currency pair is still trading around 10% lower than it was in May 2021, at the peak of the last bullish outbreak, and is now facing the first technical barrier at the 200-week moving average around $1.2880. The monetary divergence narrative and positive momentum from rising stock prices has helped risk assets like the pound recover some ground after a horrendous previous year.
However, the British currency remains at risk of priced in assumptions not playing out. It is still unknown how large the impact of tighter monetary policy on the real economy will be. The unusually high proportion of fixed mortgages, that have been unaffected by higher benchmark rates, is making the transition from monetary policy to the economy difficult. Former BoE officials have said that it will therefore take longer for higher rates to impact the economy, with the BoE estimating that only 1/3 of the hikes since the end of 2021 have fed through to consumer and businesses.
Euro and pound bursting through $1.09 and $1.28
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: June 12- June 16
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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.
