Referendum result boosts Sterling; Euro sinks on tepid TLTRO take up
22/Sep/2014 • Currency Updates•
The largest currency event risk in some time came and went last week as Scottish voters decisively rejected independence on Thursday. Sterling’s reaction was muted, with markets obviously expecting a No result and long GBP positioning was widespread. Nevertheless, the pound managed to end the week unchanged against the Dollar while the Euro sank on very disappointing TLTRO news; banks demanded less than 83 billion Euros of the ultra-cheap funding, much less than had been expected. This validates our expectations of further easing measures from the ECB before the year’s end. Markets appear to be coming around to this view, as the common currency sank against every other major currency save the yen, which is beset by problems of its own.
The referendum result was a major boost for the UK outlook, removing a significant source of macroeconomic uncertainty. Markets are now focusing squarely on the question of the exact timing of the first Bank of England hike. We are still in mild disagreement with interest rate markets. We forecast a first move sometime in the second quarter of 2015, rather than the first. The minutes of the September meeting lend some support to our view. The vote was unchanged at 7-2 against a hike, and the MPC members acknowledged the easing inflationary pressure, geopolitical risks and the severe disappointments from the Eurozone economy. Unemployment continued to drop faster than expected, but this had more to do with falling labour force participation than with job creation. Wages continue to shrink in real terms. While the data is still consistent with decent economic growth, there is little to pressure the Bank of England to move rates in the short term.
The take up by banks of ultra-cheap ECB cash in the first TLTRO tender dominated an otherwise slow week in the Eurozone. Banks borrowed just €83 billion, far below expectations of €150 billion or so. This disappointment highlights that stopping deflation and general deleveraging in the Eurozone will be harder than most anticipate. There was some slightly encouraging news about inflation, revised up slightly from 0.3% to 0.4% YoY in August. But even this was overshadowed by a sharp fall in market expectations for long term inflation. The five year forward inflation swap rate fell again and is now flirting with the lows set during the worst of the sovereign debt crisis. It is clear that ECB measures so far to arrest deflationary pressures have proven insufficient and we maintain our view that more will be forthcoming during the last quarter of 2014.
The FOMC statement last week delivered a somewhat inconsistent message on the timing of rate hikes in the US. The statement retains the key “considerable time” expression about the time that will elapse between the end of the taper and the beginning of hikes. However, the so called “dots”, which represent the members’ individual expectations for the future level of rates, rose considerably. The median of expected rates for year-end of 2015 was up 0.25% to nearly 1.5%, and that for year end 2016 rose almost a half a point to nearly 3%. This is the fastest rate of increase since the 2008-9 crisis, and it provides good support for a view that the Federal Reserve will hike rates before the Bank of England; most likely, near the end of the first quarter of 2015. This fairly hawkish message from the Fed is strongly supportive of the Dollar, which rose smartly last week against every other major currency save Sterling.