Yesterday saw a notable recovery for GBP following its recent dip to nearly two-month lows against the USD earlier in the week. Updated figures unveiled a significant surge in the UK manufacturing Purchasing Managers' Index (PMI), reaching its highest level in 20 months in March, indicating a modest uptick in activity. However, the prevailing market sentiment now leans towards the likelihood of the Bank of England (BoE) implementing more cuts than the Federal Reserve in 2024. Consequently, GBP's yield advantage has diminished, constraining its potential for upward movement.
The manufacturing PMI surpassed the crucial threshold of 50, indicating expansion for the first time since July 2022. Despite this positive development, the rebound faces challenges from tighter fiscal policies, the delayed effects of previous interest rate hikes, and subdued global demand. The final PMI survey revealed that escalating transportation costs, stemming from ongoing disruptions in the Red Sea, contributed to the sharpest increase in input prices in a year. Moreover, there are indications that these cost escalations are being passed on to consumers. Nonetheless, the influence of downward pressures from other factors should keep UK Consumer Price Index (CPI) inflation on a downward trajectory in the upcoming months. Additionally, data released by the British Retail Consortium this week showed that shop price inflation in the UK eased from 2.5% in February to 1.3% in March - its lowest level in over two years, with food inflation decelerating to 3.7% from 5.0% previously.
Market forecasts now suggest a 52% probability of the BoE implementing rate cuts as early as June, with a cut fully priced in for August. GBP/USD continues to be restrained below its 200-day moving average due to the convergence of UK-US rate differentials, while GBP/EUR remains within a narrow trading range, hovering around €1.16. If Thursday's final services and composite PMI figures confirm robust readings for the UK, the sterling may receive additional support, particularly against the EUR.
The EUR remained near a three-week low, hovering around the $1.0750 mark against the USD, as investors brace for potential policy easing by the European Central Bank (ECB) compared to the Federal Reserve this year. Money markets have raised their expectations of future ECB rate cuts, pricing in a 91 basis point reduction for 2024, following German data indicating a significant slowdown in inflationary pressures in Europe's largest economy.
Preliminary reports indicated that the headline inflation rate in Germany dropped to a nearly three-year low, declining to 2.2% year-on-year in March from 2.5% year-on-year in the previous month. This decline was primarily driven by a sharp disinflation in the goods sector, with energy costs decreasing at a faster rate and food prices experiencing their first decline in nine years. Meanwhile, services inflation remained resilient, rising by 3.7% year-on-year (up from 3.4% year-on-year in the previous month), but core inflation eased further to 3.3% year-on-year, reaching its lowest level since June 2022. Despite progress in realized inflation, the latest ECB survey indicated that expectations for inflation three years ahead remained unchanged at 2.5%, with uncertainty surrounding inflation expectations remaining steady. Given the potential self-fulfilling nature of inflation expectations, sustained anchoring of long-term inflation expectations above the ECB's 2% target could raise concerns for the Governing Council in the future.
Market attention will be focused on the preliminary Eurozone inflation data for March later today. With flash reports for the bloc's two largest economies already showing downside surprises, there is a significant risk that the headline rate for the Eurozone as a whole could follow suit, which would likely weigh on the euro. However, Federal Reserve Chair Jerome Powell's speech later today is expected to have a more lasting impact on EUR/USD, potentially increasing realized volatility as a result. Overall, EUR/USD closed the first quarter down by 2.8%, marking its worst performance in a first quarter since 2021. Nevertheless, seasonal effects may soon favour the common currency, as historically, EUR/USD tends to appreciate on average during the month of April.
