Sterling gives back some gains amid subdued FX moves
24/Feb/2014 • Currency Updates•
It was a rather quiet week in G10 FX markets. The week brought little clarity to the main recent drivers out there. We still don’t know how much of the apparent US slowdown is due to bad weather (and hence likely to disappear once the winter storms cease), nor what is the exact thinking of MPC members on the likely timeline for hiking rates, nor how close the ECB is to cutting rates again. Not surprisingly, all major G10 currencies traded in a very tight range throughout the week. The only exception was sterling, which gave up some of its recent stellar gains against both the US dollar and the euro after a mildly disappointing labour report and slight downward surprise in inflation.
The labour report for the three months to December broke the streak of favourable surprises. Unemployment rose slightly, to 7.2%. However, the more timely claimant count indicator paints a different picture, showing steady declines through January. Inflation also provided some comfort to the MPC doves, dropping below the Bank of England target of 2.0%. This weeks events likely pushed the more likely date for a raise in rates squarely into 2015. We think this week sell off against the euro and the dollar may have some legs to run on the short term, at least until the US payroll provides more clarity on the state of the US economy.
European PMI business indices provided very little fresh information about the state of the eurozone economy. They dropped slightly, but they seem to be still consistent with the lacklustre growth that we have seen since its emergence from recession, somewhere between 0.5 and 1% annualized. France continues to be the glaring exception, as all its indicators remain consistent with a fall back into recession. Since the ECB is (mistakenly, in our view) content with these quasi-stagnation, next week inflation data takes on added importance as the main indicator that could tip the ECB’s hand. Absent that, we think that the stasis on the eurozone may continue for the next few quarters and have consequently revised our EUR/USD forecast for the next few quarters upwards.
Last week brought little clarity to the issue foremost in investors minds: whether the clear softening in macroeconomic data over the past few weeks is the result of an unusually harsh winter or whether it portends a longer-lasting cyclical slowdown. The different manufacturing surveys painted a wildly divergent picture, while housing data for January unsurprisingly (given the weather) plunged. Hammered by the weather, it seems likely that first quarter growth will come in closer to 2% than to 3%. The key question is whether the second quarter will make up for this weakness, and we will not have a clear read on that until April or may at the earliest. Consequently, we are lowering our USD forecasts against European currencies for the next three quarters.