The European Central Bank did not close any escape routes last week. The upcoming days will reveal whether the remaining major central banks – the Federal Reserve in the US and the Bank of England in the UK – will also opt for similarly tempered messaging. The recent data indicating the resilience of the economy makes this task more challenging for American decision-makers.
Despite the ECB meeting and numerous economic readings, volatility in the currency market was relatively limited last week, with G10 currencies recording changes of no more than 0.6% against the dollar.
This week will be busier in terms of economic data and bank statements – we would not be surprised if volatility increased. On Tuesday (30.01), the focus will be on the euro area’s Q4 GDP reading, which will resolve the issue of a technical recession. On Wednesday (31.01), China’s January PMI readings may influence market sentiment in the morning, while all eyes will turn to the Federal Reserve in the evening. Thursday (01.02) will belong to the Bank of England, but will also bring the publication of the preliminary inflation reading for the euro area in January. We will end the week with the NFP (non-farm payrolls) report from the US labor market.
PLN
Last week was challenging for the Polish currency. While it managed to recover most of Tuesday’s losses before the week’s end, it weakened against the euro and was one of the worst-performing currencies in emerging markets.
Last week’s economic data was mixed. The most interesting figure was retail sales, which once again surprised with a decline in real terms (-2.3% y/y), suggesting that we may have to wait longer for a sustained rebound in consumer spending. This also supports the view that the recovery in consumption will not have a “boom” character.
The situation for the zloty will likely depend mainly on external news, and the Fed meeting (Wednesday 31.01) could bring additional volatility. Among domestic data, the GDP reading for 2023 (Wednesday 31.01) and the PMI for the industry (Thursday 01.02) will be noteworthy.
EUR
January’s PMI readings showed a dichotomy: a surprisingly strong increase in the industry component was accompanied by a slight but unexpected drop in the services sector. Moreover, the weak results from the eurozone’s largest economies – Germany and France – contrasted with positive signals from smaller ones. The stagnation narrative continues to hold.
Regarding monetary policy, the failure of President Christine Lagarde to clearly push back market pricing for rate cuts during last week’s ECB meeting emboldened markets to up their bets for a cut in April, thus causing the euro to suffer losses. Investors currently price in an 85% probability of such a move, compared to 65% before the meeting. We believe a rate cut in April is likely, but will be paying particular attention to signals regarding inflation and labor market conditions ahead of the April meeting.
This week the focus is on Q4 GDP and price developments in January. In the context of the former, consensus expects a minimal decline, which would confirm a technical recession. HICP inflation should fare better – further improvements in this area are anticipated in the form of declines in both the headline and core measures.
USD
The USD index ended the week with a slight increase, thanks to good economic data from the US and a weaker euro. Nearly all recent readings have positively surprised. Particularly noteworthy are the GDP dynamics for Q3, which recorded an annualized growth of 3.3% compared to the 2.0% consensus forecast. Strong data, including solid household expenditures, allay some concerns about the US economy’s condition. A clear increase in the PMI for both services and industry (the latter unexpectedly exceeded the 50-point level separating contraction and expansion) also suggest that the slowdown could be milder than expected.
These good news, however, make the Federal Reserve’s task more complex. The central bank is expected to keep rates unchanged this week, and market attention will primarily focus on signals regarding prospects for rate cuts, in particular the likelihood of such a move in March. Given the strength of the US economy and the resilience of the labor market, which is only showing slight easing, we believe the Fed should push back market bets for immediate policy easing. Despite PCE inflation marginally undershooting forecasts last week (2.9% vs expected 3%), our position remains unchanged. Markets currently price in a 50% chance of a first rate cut in March, which might cause the dollar to appreciate further if policy makers were to cool these expectations. Apart from the Fed meeting, this week’s focus will be on the January NFP report, which should show a slight decline in new job creation.
GBP
The pound ended the week unchanged relative to the dollar and at its strongest position against the generally weaker euro since August. Preliminary PMI readings for January provided the currency with a good start in 2024 – all indicators increased with the composite reaching its highest level in eight months at 52.5. This dissipates some concerns about the British economy, which had been stirred by an exceptionally poor December retail sales reading. It also supports our view that several forecasters should reconsider their outlooks. This refers to the Bank of England (BoE), who predicts a “broadly flat” growth this year. It’s also worth noting that like PMI, the GfK consumer confidence index also unexpectedly increased (-19). While Britons are still pessimistic about the future, this sentiment is at a two-year low. We suspect that advances on the inflation front, which help maintain positive real wage growth and allow for lower interest rates, contribute to improving sentiments. The reduced social insurance costs in January should certainly bring relief to households.
This week the focus will be on the Bank of England. In our opinion, a 6:3 vote to keep rates unchanged is possible for the second time. However, we will be especially closely monitoring the bank’s communication regarding the likelihood of further rate increases and prospects for reductions. We believe that the BoE has sound reasons to start lowering rates later than other major central banks, and that it won’t happen before the meeting in June.
Authors: Enrique Diaz-Alvarez, Matthew Ryan, Roman Ziruk, Itsaso Apezteguia, Michał Jóźwiak – Ebury Analysts.
