PMIs suggest recession has ended

Yesterday's UK PMIs surpassed expectations, indicating that the technical recession in the UK may be over. The private sector saw its output expand for the fourth consecutive month, marking the fastest growth since May 2023. This positive trend is primarily attributed to a robust service sector, outperforming the Eurozone. Despite this, the GBP/EUR remains below €1.17, while the GBP/USD remains above $1.26, experiencing a significant reversal from a three-week high above $1.27. The currency pair appears poised for its most successful week in 2024.

While the headline PMI figures in the UK were stronger than anticipated, the focus for the Bank of England (BoE) remains on inflation. The accompanying PMI data warns that price pressures in the service sector remain elevated, potentially delaying any BoE rate cuts. Although services inflation and wage growth are expected to decrease by summer, short-term stability is anticipated, supporting the pound through favourable yield spreads. Currently, money markets predict just over 60 basis points of BoE rate cuts this year, a decrease from 75 basis points the previous week. UK 2-year yields have risen over 60 basis points since the beginning of the year, and the pound has appreciated against 60% of its 57 global peers month-to-date, up from 40% at the start of February.

Despite a dip in consumer sentiment in February, with households expressing a more pessimistic view of their financial situations and the economic outlook, the pound remains steady. GBP/USD seems to have found reliable support at its 50-week moving average, hinting at another upward movement within its two-month range. The next potential barrier is the 50-day moving average at $1.2675, followed by the 200-week moving average at $1.2850.

In addition to the preliminary Eurozone PMI data for February, the minutes from the European Central Bank's (ECB) policy meeting were disclosed yesterday, affirming the likelihood of future rate cuts, albeit not anticipated by Spring. The ECB aims to assess final first-quarter data on inflation, output, and wages before considering any decisive actions. Following a climb to a three-week peak, EUR/USD retreated, falling towards $1.08 and slipping below its 50-week moving average.

Fed minutes less hawkish

The USD experienced a decline this morning following indications in the US Federal Reserve minutes that, although the central bank is not yet close to reducing interest rates, policymakers are expressing concerns about maintaining rates at excessively high levels.

The minutes from the January meeting reiterated the importance of incoming data, emphasizing that the Federal Reserve must be assured of a sustainable return of inflation to its 2.0% target.

Contrary to market fears, the minutes adopted a less hawkish tone, leading to a decrease in the value of the USD after the announcement.  Initially showing strength, the greenback ended up relatively unchanged for the session due to its weakened state post-Fed. The EUR and GBP recorded moderate gains, while the Japanese yen experienced a slight decline.

EUR/USD at key pivot level

EUR/USD successfully breached the psychological threshold of $1.08, a short-term resistance barrier in the past week. Currently, the world's most traded currency pair is testing its 200-day moving average just above this level, influenced by a decline in US Treasury yields that exerts downward pressure on the USD.

In addition, the European Central Bank (ECB) released a report indicating that wages in the Eurozone remain relatively high, despite a modest decline in the fourth quarter of the previous year. Negotiated wage growth dropped from 4.7% to 4.5% year-on-year in Q4, signalling a stabilization in the acceleration of wage growth. While other measures of wage growth were already trending downward before this data release, negotiated wages play a significant role in Eurozone wage developments. The impact of robust wage growth on services inflation hinges on the ease with which higher wage costs can be passed on to consumers.

The flash services PMI for January revealed that the index has consistently stayed below the neutral 50 mark for the sixth consecutive month. With the overall outlook for services remaining weak, the prospect of higher wages influencing inflation appears doubtful. Although the ECB is likely to welcome the news of the slight decline in wages, it is anticipated that the central bank will approach monetary policy adjustments cautiously in 2024.

Currently, money markets are indicating a probability of over 50% for a rate cut in April, with an expectation of three additional cuts before the end of the year. This outlook is considered excessively dovish. Consequently, there is potential for the euro to appreciate against the dollar if there is a more hawkish repricing in ECB rate expectations.

Bailey Talks Rate Cuts

GBP experienced a further decline against the EUR in the short term but exhibited stability against a broadly weakened USD. This came after Bank of England (BoE) Governor Andrew Bailey suggested that the bank might reduce interest rates before inflation reaches the 2.0% target.

GBP/EUR exchange rate faced mild pressure throughout the week, with losses extending to 1.1670 following Bailey's statement to a parliamentary committee. He emphasized that the Bank doesn't necessarily require inflation to reach the 2.0% target before considering rate cuts.

Conversely, GBP/USD exchange rate saw gains during the London morning session, maintaining its advance above 1.2610. These movements were influenced more by a retracement in the 'big dollar,' as it took a breather after a strong performance in 2024.

Bailey's remarks led to increased market expectations of a potential interest rate cut as early as June. Speaking before the Treasury Select Committee alongside fellow Monetary Policy Committee (MPC) members Swati Dhingra and Megan Greene, Bailey was cautious not to trigger a significant repricing in rate cut expectations. He noted that the economic recession in the second half of 2023, while present, was relatively weak, with a contraction of -0.5%.

Despite the GBP's robust start to the year as expectations for an early BoE rate cut diminished, this trend reversed after the latest inflation data for January fell below both market and BoE projections. While inflation is anticipated to reach the 2.0% target in April due to reduced household energy bills, the Bank foresees a return towards 3.0% by the end of the year.

Bailey contends that this inflation outlook necessitates caution, emphasising the need for the Bank to remain vigilant and not hastily pursue the rate-cutting process.

USD finding some short-term support

Surprising increases in US producer and consumer prices last week have prompted a downward adjustment in market expectations for the Federal Reserve's potential interest rate cuts this year. Current futures pricing indicates a projection of approximately 90 basis points in cuts for 2024, down from the 160 bps forecasted at the end of the previous year. This shift has resulted in a rise in US yields, bolstering the US currency across various markets.

While goods prices continue to decrease, service inflation, even when excluding shelter costs, remains persistently resistant. This resilience supports the stance of Federal Reserve officials resisting an immediate rate cut. The stock market experienced a mild reaction, initially responding to the higher-than-expected inflation report with a setback but recovering as data revealed a slowdown in economic activity through weak retail sales.  It's important to note that January economic reports tend to be noisier due to the volatile impact of holidays, weather, and one-off events typical in the first month of the year.

Looking ahead, key events include the release of US consumer confidence, existing home sales, and flash PMIs this week. However, Wednesday is particularly crucial with the publication of the Fed's meeting minutes and the quarterly earnings report for Nvidia, a significant player in the market. Presently, the strength of the USD is not only due to its appeal but also reflects a lack of attractiveness in other assets. The ongoing trend is expected to persist until there is a shift in market sentiment or when the Fed decides to implement rate cuts, signalling a potential resumption of the USD downtrend.

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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