Euro continues to fall as markets price ECB move in June
27/May/2014 • Currency Updates•
The euro continued its broad downward trend against the other major currencies last week. The previous week’s disappointing Eurozone GDP data and the downbeat tone from Draghi’s latest communications all but ensured that the ECB will take some sort of easing action at its June meeting. The common currency fell throughout the week against both sterling and the dollar, which are rallying in tandem against all other major currencies. This is not a surprising development, as the Bank of England and the Federal Reserve are the only two G10 central banks whose next move in rates is expected to be a hike. It remains to be seen which of them will move first. We expect the Federal Reserve to move first, though we acknowledge it will be a close finish.
Last week was dominated by the release of the Bank of England’s May meeting Minutes and the inflation data for April. While neither provided significant surprises, they both nudged the outlook for rate hikes slightly forward in time. In the Minutes, a mention that “for some members, the monetary policy decision was becoming more balanced” has clearly hawkish overtones, as it seems to suggest that “some” members are leaning towards hikes sooner than the market expects. Inflation surprised on the upside, as core inflation jumped from 1.6% in March to 2.0% in April, driven almost entirely by an unexpected jump in transport services, airfares in particular. The ONS noted that the Easter calendar effect had a big impact in the figures, and we expect the effect to mostly disappear in the May numbers, which should show both headline and core in the 1.6-1.7% range YoY. Overall, the numbers suggest that second-quarter GDP growth will come in close to 3.5%, well above trend and consistent with a scenario of sterling appreciation.
The PMI business sentiment indices provided some solace last week, after the dismal first quarter GDP numbers of the week before. The composite index dropped slightly (0.1) to 53.9. However, we note that a gap has opened up between the PMIs (which had traditionally been the best leading indicator for growth numbers) and GDP growth, as the former has overestimated the latter consistently since mid-2013. The Bundesbank published further negative news about European growth. Mild weather added 1-1.5% to German first quarter numbers. Adjusting for that, European growth would have stalled to a barely noticeable 0.4% Saar. Little wonder Draghi sounded very downbeat today from Portugal, stating that a “pernicious negative spiral” of low inflation and weak lending are significant risk to the Eurozone’s recovery. We maintain our view that in June the ECB will announce a cut in rates, measures targeted to easing credit for SMEs, and a renewal of the LTROs unlimited liquidity offerings for Eurozone banks.
The second-tier reports out last week in the United States provided little additional information about the state of the economy in the second quarter. New single-family home sales continue to struggle, and the expected bounce back from the weather-depressed winter levels has not quite materialised yet in this sector. On the other hand, manufacturing surveys generally rose and are now consistent with a significant acceleration of manufacturing production. We think these two reports (housing and manufacturing) roughly cancel each other out in terms of their impact on growth, and continue to expect growth in the 3-3.5% range for the second quarter.