Written by George Vessey & Boris Kovacevic
Pound pressured before inflation test
GBP/USD has dropped nearly 6% since its 2023 high of $1.3144 in July. At the same time, investor expectations for the Bank of England’s (BoE) peak Bank Rate have been slashed from 6.5% to 5.5%. There’s even a chance the BoE might choose to pause this Thursday, which is weighing on sterling.
The BoE has made it clear that it thinks keeping rates elevated for a long period of time is now more important than how high they peak. Therefore, the UK central bank might opt for a Fed-style strategy, whereby it pauses this month but firmly hints that it could hike again in November. This would draw out the tightening cycle and keep the near-term discussion more about how many hikes are left as opposed to toying with the timing of rate cuts. Although a BoE pause is not our base case given wage growth remains so strong and services inflation sticky, such a move cannot be ruled out. This would likely create the biggest reaction in the pound too as markets are pricing just a 20% chance of it happening. The reaction would likely be negative enough to drag GBP/USD under $1.23 and GBP/EUR to €1.15, though this also depends on the pound’s reaction to the UK inflation report tomorrow.
Usually, a beat of inflation expectations would be supportive of the pound and a miss unsupportive. However, in the current environment, even a hawkish inflation surprise could prove to be detrimental as fears of UK stagflation swell.
Hawkish hold to support dollar?
The US dollar remains not too far from a 6-month peak against a basket of currencies as a plethora of key central bank decisions loom over the next few days. Money markets expect the US Federal Reserve (Fed) to keep interest rates unchanged on Wednesday, though focus will be on the central bank’s forward guidance.
With the market fully pricing in a hold, investors will be looking for any hints that the Fed may be leaning towards another hike by year end or that a more persistent pause is in order. A hawkish hold, hinting at another hike, as well as upwardly revised economic and rate projections will likely boost dollar demand. A big dovish revision of the 2023 dot plot seems unlikely given the evidence of US economic resilience since the last projections in June. Therefore, any dollar weakness in the near-term may be short-lived until we see more US economic data start to disappoint.
On the data front, the NAHB housing market index declined for a second month to 45 in September, meaning homebuilder sentiment is at a 5-month low as high mortgage rates choke consumer demand and builder confidence. Today, the US calendar includes housing starts and building permit figures for the month of August, which are unlikely to impact markets.
C$ gains ahead of CPI print
With Canadian inflation data for August month due this morning, USD/CAD is currently trading 0.6% up WTD and 0.9% up versus last week. There are fears that inflation could surprise to the upside (consensus of 3.8% y/y for August versus 3.3% y/y in July), thus re-fueling rate hike expectations and supporting CAD’s weekly gains thanks to comparatively hawkish BoC. However, with Fed’s decision on Wednesday, the market might be reluctant to position itself clearly in case Fed decision or forward guidance brings about any surprises.
CAD surges close to 1% in a week
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.
