ECB expected to hold rates

GBP demonstrated relative stability during the midweek announcement of the Spring Budget, disappointing those hoping for a stronger currency but providing relief to those who recall the aftermath of the Liz Truss budget collapse.

Truss's legacy highlights the high cost of unfunded stimulus, prompting her successors to prioritize maintaining UK fiscal credibility. This commitment is seen as a foundation for potential longer-term advancements in the Pound.

The budget, slated to stimulate the economy, reveals a net fiscal policy loosening of £13.9BN (0.5% of GDP) for the 2024-25 financial year. The Office for Budget Responsibility's optimistic projections for UK growth and anticipated improvements in disposable incomes contribute positively to the Pound's outlook.  However, the government's announcements are not expected to have a substantial impact on the Bank of England. In the short term, Pound-Euro remains within a narrow range, albeit with a slightly bearish momentum that could test support at 1.1658 soon.

The ECB event today introduces the possibility of volatility in EUR exchange rates. Although no rate changes are anticipated, the market eagerly awaits any hints regarding potential future cuts. The ECB will likely maintain guidance, acknowledging improved inflation trends but emphasizing caution before considering interest rate adjustments.

President Lagarde's press conference, known for its potential to spark excitement, requires careful communication to avoid unintended consequences. This scenario may present opportunities for advantageous transactions between buyers and sellers of euros. Nevertheless, significant movements are expected to be tempered as the established range in the chart continues to be respected.

Egypt Devalues Currency

In response to a severe economic crisis, Egypt opted for a substantial devaluation of its currency, causing it to weaken by approximately 35%. This move followed a significant interest-rate hike by the country, marking its most challenging economic period in decades. The Egyptian pound plummeted to 48.18 per dollar by 12 p.m. in Cairo on Wednesday, contrasting with its stability around 30.9 over the past year. The decision to devalue came shortly after an unscheduled central bank meeting, where officials announced a 600-basis-point increase in the key rate to 27.25%, emphasizing the market's role in determining the exchange rate.

The central bank's statement highlighted the importance of unifying the nation's exchange rates, a move seen as crucial. This strategic decision is likely to pave the way for an agreement with the International Monetary Fund (IMF), potentially increasing Egypt's existing $3 billion loan to more than $10 billion, including contributions from other partners.

The recent $35 billion deal with the United Arab Emirates, aimed at developing parts of Egypt's Mediterranean coast and beyond, set the stage for this devaluation. Described as Egypt's most significant investment commitment ever, the scale of the agreement surprised investors. Tuesday's decisions prompted a notable rally in Egypt's dollar bonds, with government debt maturing in 2047 leading the way, gaining 4 cents on the dollar to reach around 82 cents.

This devaluation aligns the pound more closely with its black market value. Encouraged by the IMF to tighten monetary policy to combat nearly 30% inflation, Egypt's central bank expressed a commitment to a more flexible official exchange rate. The Monetary Policy Committee stated its decision to accelerate the monetary tightening process to expedite the disinflation path and ensure a decline in underlying inflation.

With the Muslim holy month of Ramadan approaching, authorities faced an informal deadline to implement the devaluation. Given the period's significance for family gatherings and expansive evening meals, authorities were unlikely to wait until the start of Ramadan to introduce a sudden price shock to the Egyptian population.

Focus is on the UK Budget

GBP made gains against the USD, surpassing the $1.27 mark and reclaiming a position above €1.17 against the EUR yesterday. This upward movement seemed to be a result of the selling spree of the USD following the ISM report. Today, attention is focused on the UK Budget, and if moderate tax cuts contribute to a steady increase in UK gilt yields, the pound could experience an upward jolt.

UK Chancellor Jeremy Hunt faces a delicate balancing act in determining the scope of fiscal measures, given the challenges of a persistent inflation outlook and lack-luster growth forecasts in the UK economy. The government's net borrowing position remains a key consideration, requiring a careful balance between economic recovery efforts and fiscal responsibility. The challenge lies in supporting public services, stimulating economic growth, managing the national debt, and responding to external economic pressures.

With the UK economy having entered a recession in the final quarter of 2023 and the market adjusting expectations for Bank of England (BoE) rate cuts, Chancellor Hunt's fiscal flexibility is limited. The possibility of significant tax cuts ahead of a potential 2024 election may be less likely. The market's repricing of BoE rate cuts has led to higher borrowing rates in recent weeks, constraining Hunt's fiscal options. The reduced scope for tax cuts could increase expectations of early BoE rate cuts, putting pressure on the sterling.

On the other hand, an excessively large and unfunded fiscal stimulus could heighten concerns about persistent inflation, potentially causing turmoil in gilt yields and weighing on the pound. A moderately-sized tax relief package that avoids triggering gilt market disruptions might offer some support to the sterling, possibly pushing GBP/USD closer to its 2024 peaks around $1.28. While the UK gilt market experienced a significant downturn 18 months ago, a similar level of turbulence is not anticipated today. Nevertheless, surprises are always possible in the financial markets, and traders should remain vigilant.

UK Retail Sales Disappoints

UK retail sales experienced a modest 1% increase on a like-for-like basis compared to the previous year, showing a slowdown from January's 1.4% gain and falling short of the anticipated 1.5% growth. This subdued performance was attributed to adverse weather conditions and persistent cost-of-living pressures, resulting in the lowest figure since August 2022. The GBP/USD exchange rate retreated from the $1.27 level in anticipation of a significant week of data and events that had the potential to impact the markets.

Amidst stability in financial markets, investors have been willing to embrace higher risks in pursuit of greater returns. Equities have been consistently reaching record highs, and Bitcoin has surged by 60% in just a month. Despite the attractiveness of the higher-yielding pound, reflected in a net increase of $3.7 billion in bets on GBP, the GBP/USD spot rate has displayed a narrow sideways movement since the beginning of the year, trailing behind global equity indices.

While the pound has only marginally benefited from the prevailing low volatility and risk appetite, the implied volatility of GBP/USD has reached levels not seen since early 2020, before the pandemic. GBP/EUR implied volatility, on the other hand, has hit 17-year lows. With expectations that the Bank of England (BoE) will implement fewer rate cuts compared to its counterparts in the coming years, the pound maintains an attractive yield profile relative to other currencies. However, the excessive long GBP positions may constrain its upside potential.

The market sentiment is subject to rapid changes, and potential tax cuts announced by the UK Chancellor tomorrow could exert upward pressure on yields, already near 15-year highs. This may provide added motivation for the BoE to prolong its decision to hold interest rates, a move that could prove beneficial for the sterling.

Monfor Weekly Update

Despite the looming UK Spring Budget this Wednesday, market sentiment remains calm in anticipation of the event. This tranquillity contrasts sharply with the conditions during the Liz Truss fiasco in October 2022, where implied volatility soared to levels comparable to the Brexit vote and Covid shock. This led to a historical disconnect with UK gilt yields surging and the pound plummeting, reaching a record low below $1.05 in GBP/USD. Since then, GBP has experienced fluctuations, recovering above $1.30 in July 2023, dropping to $1.20 in October 2023, and stabilizing between $1.25 and $1.28 over the past three months. This period of relative calm is unusual but lends support to GBP due to its high-yield appeal in carry trades. The question now is whether the upcoming UK fiscal event will disrupt this stability. While fiscal events typically don't heavily impact FX markets, the prospect of a UK election may prompt the Chancellor to unveil a significant package of tax cuts, despite constraints from increasingly tight fiscal forecasts.

UK Chancellor Jeremy Hunt has cautioned that there is a "long path" ahead to reduce Britain's tax burden, currently at its highest in 70 years. Yet, potential fresh tax cuts could exert upward pressure on yields, which are already near 15-year highs. Substantial cuts to income tax would provide additional motivation for the Bank of England to maintain interest rates at their current levels for an extended period.

The EUR staged a late recovery at the beginning of the new month, gaining momentum as a hotter-than-expected inflation print for the Eurozone boosted the common currency against the USD in the final stretch of the week. The yield on the 10-year German government bund retreated toward the 2.4% mark, down from the three-month high of 2.50% on February 29, as investors considered the subsequent monetary policy implications ahead of the ECB rate decision this week.

On a weekly basis, EUR/USD remained largely unchanged, registering only a marginal 0.1% week-on-week gain to close above the $1.0830 mark. Mid-last week, the pair entered a slight bearish streak, suggesting that further downside for EUR/USD cannot be ruled out. A breach below $1.0800 could attract EUR sellers, potentially paving the way for an extended slide toward $1.0760. Conversely, signs of a slowdown in the US economy or labour market could see EUR/USD testing $1.0870 before confronting the psychological barrier of $1.0900.

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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