Monfor Weekly Update

GBP initially gained support from last Tuesday's unemployment figures, which showed a lower rate of 3.8% in January compared to the forecasted 4.0%, coupled with stronger-than-expected wage growth at 5.8% versus the anticipated 5.6%. However, on Wednesday, GBP faced pressure as a weaker inflation result was reported, and Thursday confirmed that the UK had entered a recession. GBP experienced a boost on Friday when data revealed that UK retail sales had surged at their fastest pace in almost three years in January.

Despite the recent setbacks, expectations regarding the Bank of England's (BoE) monetary policy outlook remain more hawkish compared to other major central banks. The likelihood of BoE interest rate cuts has reduced, with less than three 25 basis points of cuts projected for 2024. This has helped limit the weakness of GBP, allowing GBP/EUR to regain the €1.17 level, although it had fallen sharply from its recent 18-month highs and suffered a third consecutive weekly decline. GBP/USD also declined for a third straight week but found support at its 50-week moving average and is now back above the $1.26 mark at the beginning of the week.

While fundamental risks persist due to growth differentials favouring the still-high-yielding USD, there is agreement in the market that the BoE is likely to maintain higher interest rates than the Federal Reserve (Fed) and the European Central Bank (ECB) for an extended period. This expectation supports GBP over the long term, given the preference for yield differentials.

The key domestic risk event for GBP traders this week will occur on Thursday when flash PMIs for February are released. Positive readings, building on the improvements seen in January for both manufacturing and services sectors, are expected to further bolster demand for GBP.  GBP currently remains well supported, and there is no apparent reason for this trend to change over the next few weeks.

EUR maintains a lateral trading pattern against the USD, staying above the $1.07 level, situated squarely within its six-month trading range. Despite the reduction in cumulative rate cut expectations for ECB easing by the year-end, any potential upward movement for the EUR/USD seems constrained, with a heavy resistance at $1.0850.

UK Retail Sales rebound surprises markets while Tory's get hammered

Following yesterday's revelation that the UK entered a technical recession at the close of last year, today's positive retail sales data helps explain the Bank of England's (BoE) lack of concern about the GDP figures. UK retail sales experienced the most significant monthly increase in nearly three years, fostering optimism that the economy has already stabilized. While the pound showed a modestly positive response, its performance remains mixed across the board for the week.

In January, the volume of goods sold in both physical stores and online in the UK surged by 3.4%, marking the highest growth since April 2021 when the economy was emerging from lockdown. This exceeded expectations of 1.5% and aligns with recent survey findings indicating an uptick in economic momentum as the severe cost-of-living crisis, the worst in a generation, begins to ease. The positive news comes as a welcome relief for UK Prime Minister Rishi Sunak, who had to contend with yesterday's recession headlines. Although the Conservative Party has been facing mounting challenges, the likelihood of staying in power this year seems to be diminishing, especially after the opposition Labour Party overturned significant Tory majorities to secure two parliamentary seats overnight.

Surprisingly, financial markets, particularly UK assets, have shown a relatively muted reaction to these developments. This holds true for GBP/EUR, where implied volatility has dropped to its lowest level since 2007. The currency pair has experienced a slight increase, reaching €1.17, and while volatility remains low, the pound is poised to benefit from carry trades. On the other hand, GBP/USD hovers around the $1.26 mark following a modest temporary increase. Despite this, the pound is still on track for a weekly loss against the dollar, marking its fifth decline out of seven weeks, given the impact of this week's significant data releases.

UK hits Technical Recession in shock GDP release

This morning's GDP data unveiled that the UK experienced a technical recession last year, with the fourth-quarter figure registering at minus 0.3%, falling below expectations. GBP/USD is currently trading in the mid-$1.25 range and is contending with its 200-day moving average. In the event that this crucial support level falters, our attention turns to the 100-day moving average at $1.25 as the next short-term downside target.

All three major sectors of the UK economy contracted from October through December. The services sector, constituting approximately three-quarters of the economy, saw a decline of 0.2%. Production, encompassing manufacturing, suffered a 1% drop in output, while construction contracted by 1.3%. Although the economy has contracted for two consecutive quarters, the GDP estimate for 2023 indicates a 0.1% increase compared to 2022.

For the Bank of England (BoE), the result has minimal impact on the interest rate outlook. Of greater significance, recent data revealed lower-than-expected UK inflation in January, with declining costs of food and household goods fostering expectations that inflation could approach the BoE's target by summer. The pound experienced widespread daily declines as traders anticipated more pronounced and earlier interest-rate cuts. The current market outlook suggests the BoE will implement just over 70 basis points of cuts this year, up from 61 basis points at Tuesday's close following stronger-than-expected wage growth figures.

Despite the short-term prospects for sterling appearing potentially weaker, we maintain the view that 2024 could witness a modest recovery against the US dollar and euro. This optimism is primarily rooted in the higher UK interest rate outlook, with expectations of fewer rate cuts by the BoE compared to the Fed and ECB.

Euro in Flux: ZEW Surges Amidst US Inflation Jitters, ECB Easing Expectations

Yesterday's headlines were dominated by the US inflation report, triggering fluctuations across financial markets. This led to the EUR/USD pair retracing towards $1.07, unable to surpass its 100-day moving average just below $1.08. Meanwhile, the German ZEW index, somewhat overlooked, extended its growth streak for the seventh consecutive month.

The ZEW index gauges financial analysts' evaluations and expectations regarding economic and financial developments. Although the current assessment component declined to -81.7, the lowest since June 2020, the outlook for Germany showed improvement, suggesting that Europe's largest economy might have already weathered its lowest point. However, the recovery path faces significant challenges, likely curbing the euro's rebound, especially against stronger currencies like the pound and US dollar.

A notable portion of ZEW respondents anticipates interest rate cuts by the European Central Bank (ECB) in the next six months due to declining inflation rates. Despite recent adjustments in expectations for early ECB cuts, the cumulative easing expected for 2024 is projected to surpass that of the Federal Reserve or the Bank of England, putting downward pressure on the euro.

Looking ahead, the spotlight shifts to today's release of the second estimate of fourth-quarter Eurozone GDP and industrial production. These indicators could influence euro volatility, setting the stage for tomorrow's eagerly awaited US retail sales and industrial production data.

Sterling looking strong post jobs report

Sterling remains robust following the release of the UK jobs report this morning, revealing resilient wage growth and an unexpected drop in the unemployment rate. Total earnings, inclusive of bonuses, demonstrated a strong annual growth of 5.8% in October to December 2023, while excluding bonuses, it reached 6.2%—both surpassing consensus forecasts. This positive economic data may provide the Bank of England (BoE) with further justification to maintain higher interest rates for an extended period.

While the prospect of sustained high interest rates in the UK raises concerns for consumers, businesses, and politicians, it has concurrently allowed the British pound to maintain an appealing yield advantage over its global counterparts. The current premium of UK government bond yields over those in the rest of the G10 stands at over 110 basis points, a significant contrast to the 10-year average of just 20 basis points. Consequently, speculators have taken sizable long positions in sterling, totaling $2.71 billion—one of the largest seen in the past decade.

After receiving support at its 200-day moving average last week and advancing beyond the $1.26 mark against the US dollar, sterling continues to outperform other G10 currencies against the USD year-to-date. Particularly noteworthy are its substantial gains against the low-yielding Japanese yen, with a notable 5% increase since the beginning of 2024 and an impressive 52% surge since its post-pandemic low in March 2020.

The BoE's concern over inflation surpassing its 2% target dissuades any consideration of a premature rate cut, and today's job data reinforces this perspective. Although there is a minor probability of a BoE rate cut in March, the more plausible scenario is anticipated in June, as traders eagerly await the release of the latest UK inflation figures tomorrow.

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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