The much-anticipated US inflation report released yesterday failed to disrupt the prevailing market inertia. GBP/USD experienced a modest 0.4% fluctuation but closed the day lower, remaining within its 3-month trading range. Despite historically low realized volatility, the implied volatility in GBP crosses is currently at multi-year lows, indicating a lack of anticipation for increased market activity in the near future.
With the upcoming UK Spring Budget next Tuesday, market sentiments remain calm in contrast to the turmoil witnessed during the Liz Truss fiasco in October 2022. During that episode, implied volatility soared to levels comparable to those seen during the Brexit vote and the Covid shock, leading GBP/USD to hit a record low below $1.05. Subsequently, the pound experienced a recovery to over $1.30 (July 2023), a fall to $1.20 (October 2023), and has since stabilized within the $1.25-$1.28 range over the past three months. While this period of tranquility is atypical, it reinforces the GBP's appeal in high-yield carry trades.
As the UK fiscal event approaches next week, the prevailing question is whether it will disrupt the current stability. Usually, the GBP reacts minimally to such events; however, considering an impending UK election, the Chancellor might unveil a relatively substantial package of tax cuts despite the constraints posed by increasingly tight fiscal forecasts.
The EUR maintained its position above the $1.08 threshold as downward pressure on the US dollar from US PCE price figures and lower-than-expected German inflation data created an opportunity for the European Central Bank (ECB) to consider interest rate cuts starting in June.
Initial CPI reports from major European economies revealed a decline in Germany's inflation rate to 2.5% in February, below the market's anticipation of 2.6% and hitting the lowest level since mid-2021. Simultaneously, France experienced a decrease in its inflation rate to 2.9%, marking the lowest level since January 2022, while Spain recorded a six-month low of 2.8%, slightly surpassing market expectations of 2.7%. Despite recent positive inflation surprises, the ECB remains cautious, warning against premature declarations of victory over inflation.
ECB President Lagarde stressed on Monday the importance of additional evidence confirming that price growth is moving towards their target before considering monetary policy adjustments. Some Governing Council members are awaiting clearer wage growth data before endorsing a policy rate cut. Nevertheless, investors have revised upward their expectations for an ECB rate cut in June, with the probability rising to 79%, up from 73% at the beginning of the week. Overall, money markets anticipate a cumulative 91bps rate cut by year-end.
