FX outlook: Parky’s quick take – 14 February 2022

Over the course of the last week, the markets have increased their expectations about the number of hikes from the Bank of England between now and the end of the year.

United Kingdom: Bank of England rate expectations continue to rise

The provisional Q4 Gross Domestic Product (GDP) data reported a slightly slower pace of growth quarter on quarter, but a less severe contraction in output in December due to the rise in Omicron COVID infections and the re-introduction of restrictions associated with it.

The increase in UK interest rate hike expectations comes in spite of comments from Bank of England (BoE) Governor, Andrew Bailey, that inflation was projected to undershoot target towards the end of the 3 year forecast horizon based on market interest rate expectations, which have increased since then. The BoE Chief Economist, Huw Pill, was also optimistic that bottlenecks, widely believed to be behind much of the import-led rise in inflation, were beginning to ease, and in his most recent comments tried to downplay the risks of bigger jumps in interest rates per meeting.  

The initial response of the GBP was predictable, as it rose to three-week highs against the USD and back above €1.19 in GBP/EUR following the drop below €1.18 at the end of the previous week. Whilst the GBP maintained its gains against the EUR, it fell back against the USD, as expectations grew about even faster rate rises from the US Federal Reserve.

This week’s data calendar, which includes labour market data for December/January, January consumer prices and January retail sales figures, is unlikely to re-adjust interest rate expectations, in fact these figures may only intensify rate hike predictions in financial markets if these figures record an overshoot of inflation, as seems the risk. GBP might struggle for additional upside beyond €1.20 and in the $1.3650/1.37 region. However, the question remains, are markets already pricing in too many rate hikes for the UK given how immature the economic recovery is?

US: Consumer prices continue to overshoot; Fed officials argue for swifter tightening

Last week’s focus in terms of US economic data and surveys was firmly on the January consumer prices data, released on Thursday. These reported another overshoot of both the headline and core rates, to fresh multi-decade highs. However, whilst this prompted traders to bet on larger and more frequent interest rate increases from the Federal Reserve, the damage that inflation is doing to consumer confidence was also apparent in University of Michigan’s February consumer sentiment reading. That fell sharply, to its lowest reading since September 2011, when the global economy was recovering from the financial crisis.

So the situation is far from clear cut. Consumer confidence is shaken amidst falling net disposable incomes with wages failing to keep pace with consumer prices despite growing evidence of labour shortages. There is clearly a split amongst the Fed members as well, as commentary last week from St Louis Fed President Bullard indicated he supported swifter action on monetary policy tightening, but Richmond Fed President Barkin was yet to be convinced of the need. Cleveland Fed President, Loretta Mester wasn’t convinced either, signalling that inflation expectations are well enough anchored so as to undermine the case for such aggressive monetary action at this juncture.

This week sees the release of January producer prices, retail sales and industrial production data ahead of the Federal Open Market Committee’s minutes from its January meeting. There are also February Empire manufacturing, National Association of Home Builder’s housing market and Philadelphia Fed business outlook surveys due. The data and surveys could demonstrate that the risks to the US economy are shifting, which might undermine the recent rise in yields and prompt a fall in the US dollar.

Europe: ECB’s Lagarde cautions restraint in tightening

Last week’s major economic events from Euroland were a mixed bag.  German industrial production unexpectedly fell in December, but November’s outturn was revised up.  Italy recorded a larger fall in its industrial output, the Sentix investor confidence index rose more than anticipated in February, whilst the European Commission's winter economic forecast reported a short term slowing in activity with 2022 growth revised down to 4% versus the Autumn prediction of 4.3%, but 2023 numbers revised up from 2.4% to 2.7%.

So the pace of recovery is expected to be slower, but gathering momentum throughout the course of the next few quarters before slowing into the end of the year, according to the quarter by quarter projections.

The European Central Bank President, Christine Lagarde, used an interview with a German media outlet to, again, provide a more cautious tone to the inflation and interest rate debate. Her comments, in particular about the damage that raising interest rates too quickly could do to the economy and jobs should be respected by the markets. Moreover, she indicated that rate rises would do very little to solve any inflation problems being faced by the Euroland economy in the short term. The EUR suffered as interest rate differentials again moved unfavourably for the currency, but there may prove to be a first mover disadvantage for currencies whose central banks chose to hike rates aggressively in the coming months and quarters.

For the week ahead, the main interest from an economic standpoint comes from the German ZEW survey (that measures economic sentiment) for February, on Tuesday, along with Q4 employment and GDP figures released later that day. All of these should report positive progress, albeit sluggish GDP growth has already been recorded in provisional readings. On Wednesday, Euroland industrial production figures for December are set to record further recovery in activity, according to market consensus, but risks are likely to the downside on this release.  There are also a number of key speeches this week, including from Lagarde, Villeroy and Lane, as well as the latest economic bulletin.

As for the EUR, that may enjoy some temporary relief if the data does show some more consistent improvement, but with other releases likely to intensify rate hike expectations in other economies, the relief is likely to be nothing more than that, in my view.

Central banks: Inflation continues to spook central banks; few decisions due this week

Last week’s central bank decisions included hikes from the National Bank of Poland, to 2.75% from 2.25%, the central bank of Iceland, again to 2.75% (but this time from 2%), and the central bank of Romania who surprised with a 50-basis point hike to 2.5%. However, it was towards the back end of the week where the central bank decisions, though expected, were of greater interest. Banxico hiked Mexican official rates to 6%, the highest level since May 2020, and the Russian central bank hiked to 9.5% and almost 5-year high. There are clear signals that some central banks remain far more concerned by the leap in inflation, and far less optimistic that it will easily be brought back under control. Commodity prices continue to rise, with materials shortages seemingly being driven as much by speculation as actual demand.

This week sees meetings of the central banks of the Philippines and Turkey. Neither are expected to adjust interest rates, with the Philippines still looking to support activity and Turkey still trying to navigate an entirely self-inflicted set of problems. If there is to be a surprise, it could come from the central bank of Turkey, but there is no logical reason for them to add to the problems that already exist for the economy and the Turkish Lira.

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