Sticky Rates, Sticky Dollar
Pound at risk: inflation expected to fall below 2.0%
The British Pound may decline next week as inflation is expected to fall below the 2.0% target.
Economists predict UK headline CPI inflation likely dropped to 1.8% for September, influenced by falling global oil prices. This could prompt the Bank of England to accelerate interest rate cuts, posing challenges for a stronger Pound.
Although global oil prices fell to their lowest since 2021 in September, they have since rebounded. The Pound is currently the best-performing major currency in 2024, supported by a cautious Bank of England, which has cut rates only once in August.
With a 5.0% Bank Rate, the highest in the G10, UK assets offer attractive returns for international investors, boosting the Pound, which reached €1.2000 against the Euro and $1.3400 against the Dollar. However, comments from Governor Andrew Bailey on October 3 about potential rate cuts caused the Pound to decline.
While lower headline inflation is positive, it may not affect persistent inflation factors. The Bank could overlook this, especially with rising oil prices due to Middle Eastern tensions.
Analysts at Morgan Stanley expect a decline in services inflation, which reflects domestic economic realities. Without a significant drop, headline inflation may rise above 2.0% again.
A decrease in services inflation would benefit the Bank and could accelerate rate cuts. Economists attribute the expected decline in services inflation to falling airfares and hotel costs.
No Major Data
EUR/USD steady but vulnerable
EUR/USD has stabilised in the $1.0900 -$1.1000 range but faces downside risks, as a 130bp gap in USD two-year swap rates suggests levels below $1.0900. Tensions in the Middle East could further pressure the oil-sensitive Euro. Developments from China this weekend will likely influence EUR/USD, as positive news tends to support the Euro and may help it hold above $1.0900 early next week.
The Eurozone calendar is light, with the ECB in a quiet period before next week’s meeting. The latest ECB minutes offered little clarity on potential rate cuts, and while arguments against a cut exist, it would take significant resolve to hold rates steady, as markets anticipate a 25bp reduction.
In the UK, August growth figures were slightly softer than expected, with 3M/3M GDP slowing to 0.2% and industrial production declining 1.6% YoY. Although this data is minor for the Bank of England and hasn’t significantly moved Sterling, it adds to the narrative that a dovish repricing in the Sonia curve is due. Encouraging services CPI next week is needed for GBP/EUR to fall below €1.1904.
No Major Data
US data dilemma: inflation rises, job market wobbles, and global tensions mount
The latest US data has sent mixed signals to the Federal Reserve and markets. CPI inflation exceeded expectations, with the core rate rising from 3.2% to 3.3% year-on-year. Typically, this would boost the Dollar, but two key factors have limited its reaction.
Both the Fed and markets are focused on the job market, making CPI data less impactful. A surprise increase in jobless claims, possibly due to extreme weather, negatively affected the Dollar.
Room for dovish repricing is limited, with markets expecting around 45 basis points of easing by year-end. Some FOMC members have dismissed the hot CPI figures, while only one, Raphael Bostic, is considering a pause in easing.
The relationship between rates, data, and the Dollar may weaken leading into the US election, and recent movements support this. We’ll focus more on external factors than on US data like PPI.
Oil volatility remains a key concern, with crude prices fluctuating as tensions rise over potential Israeli retaliation against Iran. This uncertainty may continue to support the Dollar in the short term.
Additionally, tomorrow’s announcement of new stimulus measures in China is anticipated. A package of around 2 trillion Yuan is expected, but market reaction will hinge on spending targets, particularly for consumption. Even with a positive response, it’s uncertain whether USD/CNY will drop before the US election. A near-term strengthening of DXY to 103.50 remains possible.
Data:
1:30pm - Core PPI m/m
1:30pm - PPI m/m