Demand for the euro resurfaced towards the end of last month. The latest flash inflation estimate has shown price pressures eased further to 0.5%y/y. For yet another month, the market remains firmly focussed on the ECB and whether the latest reading will have any impact on their stance. Considering their forecasts into 2016 suggest inflation will rise, we doubt the central bank will alter policy when they meet later this week.
In the first FOMC meeting since Janet Yellen became Fed chair, comments from the central banker suggested the Fed has more of a hawkish bias than previously thought. This has put the greenback in a better position to begin the month, and another strong payroll figure could encourage more significant dollar buying. Further comments from FOMC members will be watched closely in order to gauge whether Yellen’s comments regarding tightening were a slip of the tongue or other members also carry a more hawkish view.
The market pares back sterling holdings
The pound has advanced significantly over the past few months especially against the greenback and this has been fuelled by rate expectations in the first half of 2015. Over the past few weeks however, demand for the pound has eased and investors are reviewing their holdings of the currency. The market now feels the currency has advanced too quickly and some market participants are paring back their expectations of tighter policy.
The inflation rate has also fallen considerably and the latest reading showed price pressure continued to ease. As long as inflation remains below the 2% the BoE will be justified in its stance to keep interest rates at its current lows. Therefore we doubt there will be any shift in policy from the central bank this month. UK data will need to remain broadly positive in order to keep the currency competitive as the market looks to penalise the pound for any disappointing UK figures.
GBP/EUR
Deflation worries haven’t faded yet
Last month the single currency was supported by the preliminary reading which showed Eurozone inflation edged higher to 0.8% y/y. This reading was revised back to 0.7% y/y but with the latest figure showing inflation fell further to 0.5% y/y there is no evidence just yet that price pressures are building. We know from the central bank’s projections that the governing council still expect inflation to head towards their 2% target, with price pressures just below the benchmark by 2016. With this in mind, it is unlikely that the ECB ease policy further when they meet in the next few days. Downside risks have yet to materialise and medium to long term expectations remain firmly anchored reducing the likelihood of any change in stance from the central bank. Nevertheless, as long as inflation remains around 0.7% the question of whether further easing is necessary will remain.
Asian buyers continue to support the single currency and as long as Eurozone data comes in at least in line with estimates, we suspect the push for lower levels in GBP/EUR and higher in EUR/USD will continue. It will also be interesting to see whether the ECB take this opportunity to talk down the euro. The central bank has avoided verbally weakening the currency but at the last meeting, ECB President Draghi shed some light on the effect a stronger euro is having on inflation. Until the bank outright objects to the euro’s strength we doubt investors will hesitate to boost the currency further.
GBP/USD
Last month we witnessed a shift in rhetoric from the Federal Reserve and this was enough to at least get the market to buy dollars. In the last Fed meeting, Chair Yellen suggested that we may see US interest rates rise within the first half of next year. The central bank have said interest rates will remain low for a considerable time but the market was under the impression a “considerable” would be longer than 6months after the end of QE. Speeches from Fed members throughout the month will carry more weight as investors attempt to get a handle on the Fed’s more hawkish stance. Yellen may not have meant to give the market a timeline to look towards, either way, much more dovish talk is needed to distract the market’s attention from spring 2015.
Though the dollar is now in a more favourable position, much more impressive data is needed to keep the momentum going. Non-farm payroll figures will be published on Friday and as usual the market will penalise the greenback for any figures below consensus. We believe at least a decent reading will spur greater demand for the greenback, especially if other economic figures ahead of the release also prove to be positive. Provided the employment report is encouraging, we could see the downward trend in EUR/USD and GBP/USD really begin to take hold this month.
