Hawkish Bank of England, positive data buoy Sterling in relatively quiet week
23/Apr/2012 • Currency Updates•
Sterling was the big mover at the start of last weeks FX trading among major currencies. In an otherwise quiet week, the publication of the minutes of the Bank of England were considerably more hawkish than expected. Further, inflation in the UK surprised once again to the upside. Strategists scrambled to push back and downgrade their expectations for further quantitative easing from the Bank of England, and as a result Sterling rose against just about every major currency. Beyond GBP, stocks and commodities traded sideways, and the absence of big news out of the Eurozone supported the Euro against the Dollar.
There was mostly second-tier data out of the Eurozone last week. Construction output dropped a sharp 7.1% in February, though the drop was exacerbated by bad weather and we expect some rebound in March. Positive German IFO investor sentiment contrasted with a big plunge in car registration in France. Again, none of this news is sufficient to change the picture: the eurozone has plunged into recession, with the periphery experiencing various degrees of economic collapse and the core countries holding up better. Perhaps most noteworthy was the fall of the Dutch Government over the weekend over the refusal of the far right to impose austerity, as well as the expected defeat of Sakorzy in the first round of French presidential elections. The events out of the Netherlands are very important, as that country had been very aggressive about imposing austerity policies on the periphery. Hence,the credibility of Europe’s austerians has taken (yet another) severe drubbing. The common currency rose moderately against the Dollar, though the events over the weekend cannot be supportive. At any rate, the 1.30 through 1.35 range has proven far tougher to break than we had anticipated.
A bad week for all of us who had been calling for an increase in the Bank of England gilt purchase target in May. First, the minutes of the April MPC meeting revealed that Posen, the most dovish member of the committee, had withdrawn his vote in favor of further QE. Labor data releases were consistent with a stabilization of the unemployment rate, and the highly volatile retail sales data posted a strong upwards surprised. Finally, and perhaps more perplexing, inflation surprised to the upside yet again. While special factors again accounted for most of this surprise, if special factors become a permanent feature of the inflation landscape, they can no longer be dismissed as “special”. Further, core inflation is not slowing down as fast as the level of economic activity would imply, which seems to indicate a more permanent downgrade the the economy’s output capacity. Though our call for flat GDP growth in the first quarter remains, it appears that the economy has more positive momentum than we expected and the UK may just barely avoid a technical recession. Therefore, we delay our call for additional QE until June and will shortly nudge our short term Sterling forecast higher.
There was mostly second tier data out of the United States last week, as well. Industrial production came out as expected, and weekly jobless claims increased again, while the more meaningful four-week running average has backed up the January levels. There are some seasonality issues due to the Easter holidays, but after this week we are only a bad payroll number away from revising moderately lower our expectations for US job creation and hence the pace of economic recovery in 2012. For now, we maintain our expectations of a very slowly dropping rate of unemployment, continued housing and manufacturing revival, and 2.5% growth on average, which makes the US Dollar the most attractive currency among the major developed countries.