28.07.23: Recalibration of Central Bank Policy Expectations Will Drive Near-Term Sterling Moves against the Dollar and EuroAlthough, reaction to the
28.07.23: Recalibration of Central Bank Policy Expectations Will Drive Near-Term Sterling Moves against the Dollar and Euro
Although, reaction to the Federal Reserve policy decision was relatively muted, there have been major fireworks surrounding the ECB and Bank of Japan decisions.
Leaks from Japan and a confused announcement have amplified yen volatility.
There is also major uncertainty whether ECB President Lagarde deliberately hinted at a policy change or whether she misspoke.
Given the uncertainty and major moves across currencies, markets will have to digest the latest policy decisions.
There is likely to be at least a limited recalibration of expectations for major banks which will have an impact on exchange rates.
Conditions within the global economy and inflation developments will also be crucial elements for global markets.
In this context, Chinese developments will be watched closely and the latest PMI business confidence data will be released in Asian trading on Monday.
Firm data would offer relief while weakness would increase pressure for China to engage in a policy boost. Overall risk conditions should hold firm at this stage.
Pound US Dollar Exchange Rate Outlook
There was a weaker than expected UK CBI retail sales report on Thursday, reinforcing doubts surrounding consumer spending trends.
The Pound to Dollar (GBP/USD) exchange rate hit highs just below the 1.3000 level ahead of the ECB policy decision before sliding after the decision.
As EUR/USD slumped and the dollar regained ground, GBP/USD registered heavy losses with 3-week lows below the 1.2800 level and close to 1.2760.
The Bank of England (BoE) policy meeting will certainly come into greater focus ahead of next week’s policy decision.
Markets at this stage are expecting a further 25 basis-point rate hike to 5.25%, but are not ruling out a 50 basis-point hike.
The less hawkish than expected ECB rhetoric will trigger some further speculation that the BOE will opt for the smaller hike with less hawkish overall rhetoric.
On a near-term view, GBP/USD has scope for a limited correction, potentially towards 1.2850.
Euro (EUR) Exchange Rates Today
The ECB increased interest rates by 25 basis points at the latest meeting which was in line with consensus forecasts and took the refi rate to 4.25%.
According to the bank, the past rate increases continue to be transmitted forcefully and financing conditions have tightened again which is an important factor in bringing inflation back to target.
The Euro lost ground after the decision with hints of a less hawkish policy stance.
Bank President Lagarde stated that the near-term outlook for the Euro-Zone has deteriorated, primarily due to weaker domestic demand, although the outlook for growth and inflation remain highly uncertain.
Nevertheless, she also commented that domestic price pressures including from wages and profit margins are becoming an increasing source of inflation.
As far as the September decision is concerned, Lagarde stated that the bank is open minded as it might or might not raise rates further.
The overall stance was seen as relatively dovish and there was a scaling back of market expectations surrounding a potential September hike
Late in the press conference, Lagarde stated that she did not think that there was more ground to cover. Given the context, it appears that she might have meant that she did not want to comment, but the Euro still posted further sharp losses.
The final comments from Lagarde triggered major doubts whether there would be any further interest rate increases and the Euro posted sharp losses.
From highs at 1.1150 ahead of the ECB decision, the Euro to Dollar (EUR/USD) exchange rate slumped to 2-week lows at 1.0960 before a recovery to 1.0980.
According to Rabobank; “We maintain our call that today’s hike will prove to be the final one, but risks remain to the upside. Inflation setbacks over the summer could tip the balance towards another hike in September.”
Overall, there is scope for only a limited technical EUR/USD recovery.
US Dollar (USD) Exchange Rates Outlook
US data was stronger than expected on Thursday.
According to the advance reading, US GDP increased at an annual rate of 2.4% for the second quarter after 2.0% previously and above consensus forecasts of 1.8%.
US Initial jobless claims declined to 221,000 in the latest week from 228,000 previously and below consensus forecasts of 235,000 while continuing claims declined to 1.69mn from a revised 1.75mn .
Stronger than expected data helped underpin the US dollar with the currency index at 2-week highs as the Euro came under sustained pressure.
There was, however, no change in market pricing surrounding Federal Reserve interest rates with markets still not expecting any further rate hikes.
The dollar should be able to resist significant selling pressure while the US data stream holds firm, but has scope to correct slightly weaker.
Other Currencies
There has been very volatile trading surrounding the yen.
The Japanese currency rebounded strongly after Thursday’s European close amid leaks over a potential tweak to the Bank of Japan (BoJ) yield curve control (YCC) programme.
The BoJ officially made no changes to YCC with a 10-year bond yield ceiling of 0.5%.
The yen initially dipped sharply, but then reversed dramatically to post net gains as the BoJ stated that the target would be defended more flexibly.
There was a huge range of 176.35 – 181.80 in the Pound to Yen (GBP/JPY) exchange rate with the pair settling around 178.30.
The Australian dollar came under sustained pressure on doubts over the global economy.
The Pound to Australian dollar (GBP/AUD) exchange rate hit a 1-week high at 1.9225 before a correction to 1.9180.
There was choppy trading in the Pound to New Zealand dollar (GBP/NZD) exchange rate with the pair settling around 2.0740.
In contrast, the Canadian dollar was resilient as oil prices held a firm overall tone.
The Pound to Canadian dollar (GBP/CAD) exchange rate posted sharp losses to near 1.6900 from 1.7100.
The Day Ahead
The US will release the latest PCE prices data which is an important inflation indicator for the Federal Reserve.
Consensus forecasts are for the core index to increase 0.2% on the month with a sharp slowdown in the annual increase to 4.2% from 4.6%.
Stronger than expected data would trigger fresh concerns that the Fed will have to be more aggressive in keeping monetary policy tight,
Any comments from all major central bank will be watched closely, especially the ECB and Bank of Japan after confusion following the latest policy decisions.
Markets will continue to monitor any commentary from China surrounding interest rates and a potential policy stimulus.
Month-end position adjustment will also have a significant impact during the day.
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