Written by George Vessey & Boris Kovacevic
Sterling slides after cooling inflation data
UK inflation was lower than expected in August, falling to 6.7% from 6.8% in July, rather than increasing on the back of higher fuel costs. This marked the lowest rate since February 2022, primarily due to a slowdown in food inflation, and is a blow to Bank of England (BoE) hawks advocating another two more rate hikes before year-end.
As well as the headline print missing consensus forecast, core inflation, which excludes volatile items such as energy and food, rose 6.2%, the lowest rate since March and well below forecasts of 6.8%, whilst services inflation came in at 6.8% compared to 7.5% the month prior. The drop in almost all measures of inflation surprised economists and will put pressure on the BoE to stop raising interest rates, potentially starting from this Thursday. Money markets are now pricing a 55% probability of a 25-basis point hike compared to a 75% chance before the inflation report. This has weighed heavily on the pound, with GBP/USD slumping to a fresh 16-week low nearer $1.23 and GBP/EUR gravitating towards €1.15.
The pound had entered August as 2023’s top-performing currency. But with UK economic activity slowing, inflation cooling and BoE rate expectations being significantly scaled back, sterling is now the worst performing of the major currencies when screened over the past month.
Fed communication key for the dollar
The Federal Reserve (Fed) kicked off its two-day monetary policy meeting on Tuesday with investors and economists not expecting any change to the Fed’s benchmark policy rate later today. The incoming data as of late has been mixed but was not able to meaningfully change the market pricing of the future policy rate. Investors still expect the Fed to leave rates unchanged all throughout the first half of 2024 with the first rate cut priced for July.
This higher for longer rates regime has been supported by oil prices rising above $90 a barrel and inflation data throughout the developed world (Canada most recently) falling slower than initially anticipated. The result has been a rise in short-term yields with the rate on the US 5-year Treasury recording a new 15-year high. Equity markets have suffered from this week’s risk off sentiment with the S&P500 and Nasdaq set to fall for a third consecutive week. Investors remain cautiously positioned and are awaiting not only the Fed, but a plethora of central bank decisions later this week. The US central bank’s rate projections will be of importance as well, as it will give markets specific guidance on where policymakers see the Fed funds rate this and next year.
There have been some pockets of weakness in the US economy this week. Data published on Tuesday showed new home construction dropping to the lowest level since July 2020 against the backdrop of a sharply declining housing affordability. This has been preceded by the NAHB home builder sentiment index on Monday, which fell more than economists expected in September. The Fed’s communication following today’s rate pause will decide if the US Dollar Index records its tenth consecutive weekly increase or not.
Canadian dollar leaps after hot inflation data
The Canadian dollar continues to surge higher following hotter-than-expected inflation data yesterday. Bets on the Bank of Canada (BoC) resuming its rate-hiking cycle have ramped up following its decision to leave rates unchanged at 5% earlier this month.
The BoC signalled that future rate decisions will be based on the latest economic data. Therefore, with the headline inflation rate rising to 4% in August, overshooting market expectations of 3.8%, investors are bracing for a potential global inflationary rebound to be met with more monetary tightening. Money markets see a roughly 40% chance that the Canadian central bank will tighten next month, up from 23% before the inflation data. The rebound in headline inflation can be partly attributed to the rise in oil prices, but the above-forecast rise in core inflation and the trimmed CPI is more relevant to the BoC and money markets. Hence, the yield on the Canadian 10-year government bond soared to over 3.85%, its highest in nearly 15 years.
USD/CAD dropped to a fresh 6-week low on the news, whilst GBP/CAD slumped to a 5-month low and is on track to suffer its biggest monthly decline since March 2022.
Pound is worst performing of the G10 recently
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: September 18-22
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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.
