Monfor Weekly Update

Sterling reached a 22-month high against the Euro this month, but since then, its performance has weakened, and the GBP/EUR exchange rate has dropped to around 1.1820, where it stands at the start of this week.

There are no major data releases expected from the Eurozone this week, leading us to anticipate a gentle pullback and consolidation. It wouldn’t be surprising to see the rate test 1.18. Nevertheless, the Pound is still in a broader uptrend, with key technical indicators remaining supportive, suggesting that any weakness should be limited.

This outlook is influenced by political risks impacting the Euro, particularly due to the French legislative elections. Forward-looking financial products indicate potential volatility during the election period, with polls suggesting a 'hung' parliament. This scenario, while not the worst, is less than ideal for France, given its significant debt and investor concerns about the country's financial outlook.

Meanwhile, GBP/USD is trading near 1.2650 in the European morning on Monday. The policy divergence between the Bank of England and the Federal Reserve undermines the pair, while a stable risk tone limits any downside. The focus now shifts to speeches from Fed policymakers, with the UK and US data calendar being relatively quiet.

Last Thursday, GBP/USD dropped by 0.5% and continued to decline during the early European session on Friday, touching its lowest level since mid-May at 1.2630 before edging higher to the 1.2650 area. The technical outlook does not indicate a strong recovery momentum.

Looking ahead to the weekend, market participants will watch the latest US and UK GDP numbers, released Thursday and Friday respectively. Both the annualised and quarterly print for the UK are expected to show significant improvement versus the previous print, with YoY reversing into the green at 0.2 percent. Meanwhile the quarterly figure should rebound to an impressive 0.6 percent.

BoE hints at summer cut

The Bank of England (BoE) voted 7-2 to maintain rates at 5.25% for another month. As anticipated, the meeting had little immediate impact, with GBP/USD and GBP/EUR slipping by less than 0.4%, despite the likelihood of an August rate cut increasing from 30% to over 60%. This morning, sterling remains steady, unaffected by stronger-than-expected UK retail sales and the highest consumer confidence in over two years.

Key insights from the BoE’s statement and meeting minutes indicated a "finely balanced" decision not to cut rates, highlighting divisions among the majority about the significance of unexpectedly strong services inflation. This announcement followed data showing UK inflation had reached the central bank’s 2% target for the first time in almost three years, although the services sector inflation slowed less than anticipated. Some policymakers, despite voting to keep rates unchanged, noted that surprises in services inflation hadn't altered the economy's disinflationary path. This was perceived as dovish, leading to a slight decline in UK gilt yields and the British pound.

Sterling remains surprisingly resilient, even though it appears overvalued compared to swap differentials, particularly against the EUR and USD. This resilience might be attributed to factors beyond cyclical and monetary policy considerations, such as the prospect of more stable UK politics and improved UK-EU relations under a potential Labour Party leadership, which could act as a bullish factor.

The US dollar has experienced a relatively calm period recently, despite US yields hitting a two-month low. The dollar faced mild selling pressure as US retail sales for May rose less than expected, reinforcing a 60% probability of a Fed rate cut in September. However, dovish policy signals from Europe are helping to keep the dollar stable. Today, attention shifts to flash industry PMIs from Europe, the UK, and the US, offering an initial look at economic activity deviations for June.

Yesterday's data releases included the Philly Fed survey, jobless claims, and housing starts, all of which came in slightly weaker than expected. Despite this, US Treasury yields edged up slightly, supporting the dollar against most major currencies. Recent hawkish comments from the Federal Reserve, in contrast to its major peers, are keeping the dollar on track for its third consecutive weekly rise. Notable gains have been made against the Swiss franc, which came under selling pressure after the Swiss National Bank cut interest rates for the second time this year. The Japanese yen is also drawing attention, with verbal intervention anticipated as it trades around 158.90 per dollar, close to the significant 160 per dollar level. Meanwhile, the US has added Japan to its “monitoring list” for foreign-exchange practices but stopped short of labelling it a currency manipulator.

BoE in focus

Stronger-than-expected UK services inflation in April and May has dashed hopes for a June interest rate cut. Nevertheless, we anticipate the Bank of England (BoE) will maintain its stance that rate cuts are imminent if future data align with its forecasts. Following the latest inflation report, sterling regained strength, reaching $1.27 against the US dollar and staying above €1.18 against the euro. We do not foresee significant BoE-induced market volatility today unless the bank surprises investors.

Despite the headline CPI falling back to the 2% target for the first time since spring 2021, money markets have slightly reduced their bets on BoE interest rate cuts this year. This cautious stance is due to the key services inflation rate exceeding expectations, coming in at 5.7% versus the forecasted 5.5%. Along with election-related economic uncertainties, this is likely to keep the BoE from making any immediate changes, although we still predict the first rate cut in August. Given that the market currently sees only a one in three chance of this, sterling remains vulnerable. If the BoE policymakers' vote split is unexpectedly dovish, it could lead to a reassessment in a GBP-negative direction. However, high yields within the G10 currencies have supported sterling this year, and any BoE-driven decline in sterling may be brief if other central banks communicate and act similarly.

Today's meeting minutes will be crucial for understanding the BoE's interpretation of the latest data, as the bank has been silent since halting all communications following the UK election announcement last month.

UK inflation at 2% target after almost 3 years

Sterling has strengthened against its peers this morning following the highly anticipated UK inflation report. While the headline figure matched the Bank of England’s (BoE) 2% target for the first time in nearly three years, persistent services inflation remains nearly double its 2000-2019 average, likely postponing the BoE's first interest rate cut until August. Before the inflation report, markets saw less than a 50% chance of a rate cut; now, the probability stands at 43.3%.

Services inflation, a key measure of inflation persistence identified by the Monetary Policy Committee (MPC), was significantly higher than the BoE expected last month, quashing hopes for a rate cut at the BoE’s meeting tomorrow. This month, services inflation has remained stubbornly high, slowing to 5.7% but still exceeding the 5.5% estimate. Another critical metric for the BoE is private sector wage growth, which continued to slow in April despite a substantial increase in the national living wage that month. Assuming supportive incoming data, we anticipate the MPC will reduce the Bank Rate by 25 basis points in August and November, though next month’s general election introduces an element of uncertainty, given the limited scope for fiscal policy adjustments.

Opinion polls indicate that the opposition Labour Party is poised to win the general election on July 4 with a significant majority. This is considered the best-case scenario for the pound. However, in the short term, a dovish BoE could have a greater influence on sterling, making the currency vulnerable, especially since it appears overvalued against the euro based on interest rate differentials.

RBA Expected to Lag Behind in Central Bank Rate Cuts

The Australian dollar weakened overnight, influenced by disappointing Chinese economic data ahead of today's crucial Reserve Bank of Australia decision.  The AUD/USD fell to one-month lows, finding support around 0.6575.

Ahead of today's RBA decision, a Reuters poll published on 14 June found that all surveyed economists expect the central bank to maintain the current rates.  Australia’s latest monthly inflation report showed annual inflation rising from 3.5% in March to 3.6% in April, marking the second consecutive monthly increase.

While many other economies are experiencing easing inflation, Australia's inflation remains stubbornly high, making an RBA rate cut less likely. This could provide support for the AUD as we move into the second half of 2024.  Local financial markets don't anticipate an RBA rate cut to be fully priced in until March 2025.

China's key monthly activity data showed a slowdown in industrial production (5.6% in May, down from 6.7% in April) and fixed asset investment (4.2% in May, down from 4.0% in April), both missing expectations. Retail sales, however, showed improvement.

Adding to the bleak outlook, Chinese house prices remained stagnant, with new home prices down 4.3% in May compared to the same period last year.  The Chinese yuan also weakened, with USD/CNH rising 0.1%, approaching major resistance at seven-month highs.

In other markets, the euro strengthened, with EUR/USD rebounding from one-month lows.  The euro had been significantly lower over the past week after strong performances by far-right parties in the EU parliamentary elections prompted French President Emmanuel Macron to call snap national elections for 30 June and 7 July.  A Le Point poll, cited by Reuters on 14 June, found a "far-right" coalition at 29.5%, a "far-left" coalition at 28.5%, and Macron's centrist coalition at just 18%.  

Please note:  The news and information contained on this site should not be interpreted as advice or as a solicitation to offer to convert any currency or as a recommendation to trade.

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