Dollar rallies further on Bank of England dovishness and Eurozone growth disappointment
19/May/2014 • Currency Updates•
Calm returned to major FX currencies last week after the European Central Bank-driven-fireworks of the previous one. The return of disappointing macroeconomic news out of the Eurozone, and unexpected dovishness from the Bank of England more than outweighed soft data out of the US, and the dollar continued to rally against both sterling and the euro. We expect decisive easing from the ECB’s June meeting on a number of fronts; last week’s disappointing GDP data further underlines the precariousness of the Eurozone expansion and the need for further monetary stimulus.
The Bank of England delivered a surprisingly cautions Inflation Report last week. Even though growth expectations and the expected path for unemployment were upgraded modestly, the BoE offered no hints that the expected timetable for hikes had been pushed from the second quarter of 2015 to the first, as market pricing and strategists’ expectations had implied. This cautious stance received some justification from the unemployment report for the three months to March. Though unemployment fell again by 0.1% to 6.8%, the market had expected better. Perhaps more significantly, wage growth came in far below expectations, coming in at 1.3% annualised ex-bonus payments. This was an actual decrease in real wages, and means that the uptick in compensation seen in late 2013 has likely petered out. The pullback in rate expectations had a fairly muted impact on sterling, which ended up the week only slightly down against the euro and the dollar.
Eurozone growth in the first quarter was just 0.8% Saar. Not only was this far below expectations of 1.6%, it also means that the European economy has failed to post even 1% growth in any of the three quarters since it emerged from the longest recession in its history. This sluggish growth is insufficient to make a dent in the bloated unemployment rolls. It also calls into question the ECB staff forecast for 1.2% GDP growth in 2014. The ECB’s pristine record of wrongly optimistic forecasts over the past few years is becoming a serious drag for its credibility. Therefore, we expect significant action at its June meeting. In addition to a 0.25 cut in rates, a negative deposit rate, and action to assure the flow of credit to SMEs, we now see an extension of the LTRO full-allotment and a significant downgrade of its inflation and growth forecasts.
Weaker-than-expected data out of the US damped the dollar rally last week. Retail sales and industrial production both shrank in April, after posting large increases over the previous two months. As for the key housing market, there were conflicting signs there as well. Reflecting perhaps the recovery’s skew towards wealthier Americans, the number of new starts of single families continues to languish, but the price and size of the average new dwelling are posting strong gains. Meanwhile, multifamily starts, often associated with higher-end urban markets, have rebounded almost all the way to pre-crash levels.
We think that the signs of strength from the labour market generally trump these signs of weakness and therefore expect growth in the second quarter to come out around the 3.5% level that is consistent with monthly payroll reports, around the 200,000 new job mark.