houses of parliaments

A Tale of Two Central Bank’s; Act II – The Bank of England

20th December 2018 Market Update

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🇬🇧 GBP – Sterling was up this morning against the Dollar ahead of today’s Bank of England meeting, where markets expect interest rates will be kept on hold at 0.75 per cent amidst slowing inflation and growing Brexit anxiety. In terms of inflation, the impact of falling oil prices despite higher wages means that there is less impetus on the BoE to raise rates, especially given the lack of progress we have seen in recent weeks in terms of Brexit negotiations. As discussed in greater depth yesterday, with each passing day – the UK moves closer and closer to a ‘No Deal’ Brexit; such an outcome would be of zero benefits to all parties and so there remains some optimism that it can be avoided even now, at the eleventh hour. As far as the BoE is concerned, interest rates are currently at their highest level for a decade following August’s increase but since then we have seen a marked deceleration in economic activity, which analysts believe is largely down to Brexit uncertainty. In line with this, yesterday we saw the UK’s leading business associations urging lawmakers to remove the uncertainty as businesses approach a ‘point of no return’ as contingency plans threatened to drain both their money and time. In addition, as part of the last meeting, the BoE warned that a disorderly Brexit would likely cause GDP to fall by at least 7.75 per cent while unemployment could increase to nearly 7.5 per cent. Given the lack of progress since we last heard from them – it will be interesting to see if any of their forecasts have changed or if indeed they were now preparing for a disorderly exit from the EU, having previously chosen to focus their attention on a successful Brexit.

🇺🇸 USD – As widely expected, yesterday saw the Federal Reserve hike its policy rate 25bps to 2.25-2.5 per cent, which was a decision that was accompanied by a dovish narrative, which is an outcome that was largely priced into the Dollar’s fortunes. The Fed’s decision came as part of previously indications in September that there was every chance of three rate hikes in 2019, but since then – five FOMC members have lowered their projection to two rate hikes. In addition to this, there remains an expectation of one further rate hike in 2020, but given the amount of time between now and then – this could well change. In terms of forecasts for growth, unemployment and inflation – the Fed somewhat surprisingly left their longer term views unchanged. Furthermore, the release included additional comments that the Fed will “continue to monitor global economic and financial developments and assess their implications for the economic outlook.” This is because, the US market is likely to see continued headwinds after a relatively prosperous 2018 with output expanding at the fastest rate for 13 years, while unemployment hit a 49-year low. In the wake of the meeting, the Dollar has fallen towards a 10-day low as fears of the lagged effects of higher borrowing costs, alongside an inverting yield curve are signs of tougher times ahead for the US economy.

🇪🇺 EUR – The Euro has been a big winner this morning with the single currency up nearly half a per cent against the Dollar. While this is partly due to the weaker Dollar this morning, the news last night that Italy has struck a deal with the European Commission over its controversial 2019 budget, alongside some rare, and upbeat trade data this week have helped strengthen the Euro. As a reminder, the issues began as a result of Italy’s very high debt, and despite having initially held their ground in promises to the Italian people of greater government spending, threats of fines and disciplinary action from the EC have caused the Italian government to back down. As part of the agreement, Italy has agreed to lower its planned deficit from an initial 2.4% to 2.04%, which although a smaller decrease than Brussels would have liked, EC Commissioner Pierre Moscovi pointed to a difficult year for the Italian people as part of the lenient decision. In contrast, Italy PM Giuseppe Conte was keen to stress that the agreement was a win for both sides, and we are inclined to agree. As well as that, the big winner is also the single currency as hopes are now high that this issue will be put to bed, allowing investors to focus more on the Eurozone economy, as opposed to political headlines.

 

Summary:
GBP: All eyes on Bank of England meeting today where rates are expected to be kept on hold;
USD: Fed confirms rate increase alongside dovish narrative causing Dollar to weaken this morning;
EUR: Confirmation of an agreement between Brussels and Italy, alongside improving trade data sees single currency strengthen.

 

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Darren Kilner

Darren Kilner

Darren is Head of Dealing at FairFX. Darren lives and breaths FX, his Mastermind topics are G8 currencies and economic forecasts.

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