The start of the new year has brought a more optimistic outlook, as economic data improves, China reopens, inflation appears to be peaking, and central banks are expected to end their rate hike cycle. The focus is shifting away from concerns of a recession.

Starting state-side, US Inflation dropped to 6.5%, potentially indicating that the Federal Reserve may slow their tightening efforts in the coming months. Following the release of the inflation figures, US equity markets heavily rebounded and markedly impacting the value of the dollar.

Closer to home, growth figures in the UK were slightly better than expected, with crucial inflation and employment numbers set to be released next week, which could influence the size of the rate increase expected by the Bank of England on February 2nd. The market is divided on whether this increase will be 0.50% or a more moderate 0.25%. The projected peak for rates has dropped to around 4.40% in June, though a recent split in voting suggests the next meetings will be noteworthy.

The Eurozone economy continues to show signs of recovery, driven by lower gas prices and milder weather, though another 0.50% rate hike is likely next month as policymakers remain cautious about persistent high inflation.

GBP/USD has seen some ongoing demand below the psychological level of 1.2000 but is capped at the significant 1.2500 barrier. GBP/EUR is under pressure at its 3-month lows as the EUR strengthens across the board due to the improving economic outlook.

Summary

• GBP/EUR rate may be able to reverse some of its recent losses this week if global markets remain positive and the Sterling is able to avoid potential risks in the domestic schedule.
• The Pound traded near multi-month lows against the Euro when European inflation came in lower than expected for December and US payrolls showed lower-than-expected wage growth.
• The drop in US government bond yields and the subsequent decline of the Dollar have benefited currencies such as the Pound, which now has the potential to continue its recovery against the Euro until it reaches near 1.15.
• The market will also pay close attention to the UK GDP report for November, which is expected to show a 0.2% or 0.3% decrease, potentially leading to a recession in the UK.
• Public statements from the Governor of the Bank of England and other members of the Monetary Policy Committee will also be closely watched for indications of future changes to the Bank Rate.

Weekly Report

The GBP/EUR exchange rate appears to have stabilized after its December declines and could potentially reverse some of its recent losses this week if global markets remain positive, and Sterling is able to avoid potential risks in the domestic schedule.

Sterling had been trading near multi-month lows against the Euro when European inflation came in lower than expected for December, and just before the release of a US job report that showed lower-than-expected wage growth. The resulting drop in US government bond yields and the subsequent decline of the Dollar have benefited currencies such as the Pound, which now has the potential to continue its recovery against the Euro until it reaches near 1.15.

While the Pound may continue to gain if global markets remain positive in the coming days, much will also depend on how the Sterling handles the release of the UK GDP report for November on Friday. Forecasters predict a 0.2% decrease in GDP, which would almost guarantee a second consecutive contraction in the final quarter and the UK's entry into a recession that is expected to last for a year or more. However, the economist consensus predicts a steeper 0.3% decrease in GDP on Friday. The Pound may be influenced by any positive or negative surprises in the GDP report, but it is also likely to continue to receive support at 1.1290 and 1.1274 in the event of any renewed weakness in the coming days.

In addition to the GDP data on Friday, the market will also likely pay close attention to public statements from the Governor of the Bank of England, Andrew Bailey, as well as Huw Pill and Catherine Mann on Monday, Tuesday, and Thursday. Huw Pill and Catherine Mann are currently the most hawkish members of the Monetary Policy Committee, and there is uncertainty about how much further the Bank Rate will be raised in the coming months.

Pound Sterling ebbed further in the final session of a tumultuous year, leaving it trailing behind a majority of major currencies for 2022 while the U.S. Dollar and the Swiss Franc both remained top dogs for the period.

Sterling was holding intraday gains over the Dollar, Swiss Franc, Dollar-bloc currencies and South African Rand on Friday but continued to carry steep losses for the year against all but four currencies in the G20 grouping with only the Turkish Lira, Swedish Krona, and Japanese Yen faring worse.

Many factors have driven the Pound lower this year, but it had been an outperformer among major currencies until shortly after the Russian military first crossed into Ukraine on February 24.

Since then, symptoms of the war in Ukraine had added further to the losses sustained by the Pound including rising inflation, a deepening trade deficit, and a widening current account deficit.

In terms of data for the first week of 2023, there is a lot to cram in! Tuesday kicks things off with UK Manufacturing PMI for December, with the market widely expecting to see little change from November’s figure of 44.7. This is frustrating news for the UK’s beleaguered manufacturing sector, with little sign of changing while inflation remains high.

Wednesday sees the ISM Manufacturing PMI and JOLTs Jobs Opening figures being released state side, along with the FOMC Meeting Minutes. These minutes are likely to steal the limelight as traders analyse them for hints of future monetary policy action.

We return to the UK on Thursday for the all important Services PMI release, widely expected to come in flat at 50.0. This is followed by Friday’s UK Construction PMI.

Finally, Eurozone year-on-year inflation figures on Friday should come in just sub 10% at 9.7%. This is a 0.4% reduction on the previous figure, however given how high the number remains, we doubt markets will react in anyway other than negatively.  

A significant week for financial markets, with the Fed, Bank of England and European Central Bank all raising rates by 0.50%. Further hikes in the coming months are likely as inflation remains uncomfortably high, however, we should see rates peaking mid-2023 as the focus switches to recession. Potentially, we may see interest rate cuts later next year to stimulate growth.

The UK central bank vote was split three ways, highlighting the challenges ahead, with rates now at a 14-year high.

UK inflation dropped to 10.7%, adding to hopes that last month’s 41-year high was the peak. The jobs market remains robust, but with average earnings rising 6.1% and inflation likely to remain above 10% in the coming months, the squeeze on disposable income continues.

Critically important US inflation slowed by more than expected to 7.1%, reinforcing the view that we have now seen the peak, and the Fed will slow policy tightening.