- The weight of inflation is weighing down progress on output
- Job growth justifies rate caution
- ECB sees inflation falling to 2% eventually
Rates to continue supporting Sterling, for now
It is as if every piece of data, every comment from an MPC member, and every geopolitical event is either dissected in the search for clues or is in some way related to this thirst for clues.
This is in some ways a unique situation, many investors, traders and market commentators have never seen considerable changes in monetary policy happening and are fascinated that after such a long period of low inflation and stable interest rates, such a series of events are taking place to pique their interest.
An example of almost every piece of news being viewed through the lens of its effect on monetary policy is the Prime Minister’s claim that the airstrikes that have been taking place in Yemen currently are in self-defence. They are a direct result of the economic effect of the attacks that have been taking place over the past several months on British and other nations shipping entering the Red Sea via the Gulf of Aden.
Last week, the market’s thirst for knowledge was barely quenched by the level of data that was released. The comments made by Andrew Bailey following the MPC meeting were overshadowed, possibly intentionally, by the FOMC meeting, which had more global significance.
This week will be no better, and it may be that traders will have to wait another week until the publication of employment and inflation data on the 13th and 14th respectively, to have something to “get their teeth into”.
This Thursday, MPC member Catherine Mann is scheduled to make a speech and the market will be expecting her to continue her hawkish rhetoric about the need for continued vigilance about the dangers of inflation.
It will be a major surprise if she mellows her comments and accepts that the current level of interest rates is appropriate.
Sterling remained in a narrow range last week, as the market’s “bark was significantly worse than its bite”. Only an actual rate cut is likely to move it out of its current range versus the dollar.
It fell to a low of 1.2614 last week and closed at 1.2636.
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Average wage rise puts rate cuts back
Not only were 353k new jobs created in January, but the December figure was revised upwards from 216k to 333k.
Furthermore, average earnings were also higher than the market had expected at 4.5%. While it is generally agreed that the current level of interest rates is appropriate, the news will have provided more ammunition to Fed Chairman Jerome Powell, who continues to call for caution from those calling for rates to be cut immediately.
Although the other jobs-related data that was released last week wasn’t as strong as Friday’s employment report, there was nothing to concern the market about the prospect of a soft landing for the economy.
Several FOMC members spoke before the blackout, which begins a week before any FOMC meeting, where they are forbidden to talk about their view of the economy or their voting intentions, about their view that rate cuts are only likely to begin in the Summer.
The level of growth in the economy is barely affected by the level of interest rates.
Data released on Thursday showed that the output level in manufacturing continues to rise, although it is still in contraction, the ISM manufacturing PMI rose from 47.1 to 49.1.
Later today, the ISM report for service output will be released and this is expected to show significant strength, rising from 50.6 to 52.
Later in the week, the market will hear speeches from FOMC members Meister, Kugler, Barkin and Bowman, all of whom may be expected to provide their “take” on when rates may start to be cut.
Inflation data is due for release a week from tomorrow, and it may well be time for the Fed to declare a soft landing given the strength of the current jobs market if inflation is reported to have fallen in January.
The dollar continues to derive strength from both the economic data and the fact that rates are unlikely to fall for several months. Last week, the Dollar index reached a high of 104.03 and closed at 103.9. It is in a run of higher weekly closes that stretches back to the first week of 2024.
“Good progress” being made on reducing inflation to 2%
ECB President Christine Lagarde appears to have started a trend when she spoke in Davos recently about how economists at the world’s major banks and think tanks were wildly inaccurate in the predictions for the rise and fall of inflation that has taken place over the past year, and also calling for a recession to have already begun in the entire Eurozone.
She accepts that there have been “pockets” of contraction in certain Eurozone States, just as there has been some robust growth in others.
The experts blame several geopolitical events like the war in Ukraine and the prospect of a widening of the conflict in Gaza as being the reason they have been unable to predict how the Eurozone economy would perform.
It is unlikely that the excuse will be acceptable since there is no caveat about the effect of global events on economists’ confident expectations when they are delivered.
Lagarde who has been criticized recently for not” having a mind of her own” when it comes to voicing an opinion about the economy has remained overtly hawkish in recent months and that has been blamed on the strength of the hawks who reside on the Governing Council of the ECB.
Following its latest meeting, there appears to be no hurry in the overall thinking of the Governing Council that rates will be cut until before the Q1 wages report is published. That will take place in late April or early May, so the Market is becoming conditioned to the fact that the first cut will take place at the meeting scheduled for May 8th, at the earliest.
It is considered unlikely that there could be a cut announced between meetings since there are no signs of a significant worsening of economic performance, but rather a gradual decline.
The Chief Economist of the ECB, the normally dovish Philip Lane, reinforced the market’s view on the first cut in rates last week by stating that he believes that conditions are “unlikely to right” before early summer.
Retail sales data is due for publication tomorrow and that is likely to show a similar fall to the drop of 1.1% that took place in December.
There are no speeches scheduled from Council members this week, but even if there are unscheduled comments, the market has a fairly good idea of who the hawks and doves are, and their positions are set in stone and unlikely to move the market.
The Euro looks to have embarked on its long march towards parity. Last week, it fell to a low of 1.0780 and closed at 1.0793.
Have a great day!
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02 Feb - 05 Feb 2024
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Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.