Sterling hammered in FX markets as Bank of England Inflation Report signals "lower for longer" rates
17/Nov/2014 • Currency Updates•
Last week saw some major divergences in performance among the world’s major currencies. The Euro finally managed some semblance of stability against the US Dollar, on the back of slightly better-than-expected macroeconomic data. However, Sterling and Yen both suffered sharp losses. GBP was hit by a dovish Inflation Report from the Bank of England, while JPY simply continued the downward trend that started with the Bank of Japan’s surprise decision to expand monetary easing last month. Some key emerging market currencies, like the Brazilian Real and the South African Rand also joined Sterling and Yen in their sell off against the Dollar. BRL in particular is now at its cheapest level against the US Dollar since 2005.
Markets last week were focused on the release of the Bank of England’s Inflation Report, containing the latest revisions to the MPC expectations for future inflation. These were more dovish than the market had been expecting. Inflation is now forecast to rise back to the 2% target later in 2017, and unemployment is expected to level off just a bit below current levels. It is clear that the string of downbeat data out of the Eurozone (where growth is now forecast by the BoE at a measly 1.25% in 2015) and falling inflation everywhere, is leading the MPC to reconsider its views on the necessity for hikes in the first half of next year. Unsurprisingly, markets reacted by punishing Sterling, which fell against most major G10 currencies save for the Yen.
Eurozone economic data continues to stabilise, albeit at a disappointing level that is not consistent with either restoring sustainability to debt dynamics in the periphery nor sustained increases in employment. GDP growth in the third quarter came out at an annualised rate of 0.6%, and there were modest upward revisions to the first two quarters. Third quarter growth was therefore more or less in line with the 2014 average of 0.7%. The picture in the periphery was decidedly mixed, with Greece, Spain and Portugal all posting growth of around 2% (after dismal contractions in all three cases, it must be remembered) while Italy appears still unable to shake off recession and saw its economy shrink yet again, by 0.4%.
All in all, the picture is far from encouraging, but it is perhaps better than had been feared just a few weeks ago, when an outright contraction appeared within the realm of possibility. The common currency took some comfort, and late Friday trading in saw the sort of short squeeze typically associated with the short positioning and excess bearish consensus that has developed around the Euro. This popped higher by 1% in the span of a few hours, on little news, to end the week a bit better than unchanged against the Dollar, and much higher against Sterling.
The news regarding the state of internal demand in the US continues to improve, in line with our view of sustainable 3% growth for the next few quarters. Retail sales in October bounced back smartly from their September dip – the data point last month that triggered a brief panicked sell off in financial markets. They increased by 0.5% for the month, and the September number was revised to a flat reading from the initial -0.2% print. Further solid news for US consumption comes from the JOLTS data on voluntary job quits: 2% of employees left their jobs in October, up from 1.8% in September – a key sign of increasing confidence in job prospects among US workers. Finally, average gasoline prices nationwide have now dropped below the psychological level of $3.00 per gallon. All in all, October data paints a solid picture that is fully consistent Fed hikes sometime in the spring of 2015.