Published: 14/06/2022 By ECAPYesterday saw weaker than expected UK GDP numbers resulting in sterling being one of the worst performing major currencies. The UK economy unexpectedly contracted by 0.3% in April (+0.2% forecasted), the second straight month of contraction. This will be a big concern for the MPC at the Bank of England, which will be announcing their latest policy decision on Thursday. While market participants are overwhelmingly in agreement that another rate increase is on the way this week, there is a great deal of uncertainty as to the future path of policy during the remainder of the year. Should recent weak activity data discourage a hawkish pivot from the MPC, then GBP could be in for another rough few days.
Last Friday’s US inflation report has been the main catalyst for the recent volatile swings in FX markets. Headline US inflation unexpectedly rose to a fresh four decade high 8.6% last month, defying calls that the pace of price growth may have peaked in March. The reaction among investors has been to flock to the safe-haven assets at the expense of high-risk ones amid concerns that a more persistent inflation overshoot could damage the global economy. EURUSD has dropped below the 1.05 level and the Japanese yen has fallen to its lowest level since 1998. This is not only due to the dollar being viewed as the safe-haven currency of choice, but also a reflection of rising bets in favour of higher Federal Reserve rates.
As eyes fix on tomorrow's FOMC interest rate decision meeting, we’ve seen a fairly remarkable shift in Fed fund futures pricing in the past couple of trading sessions. Markets are now fully pricing in the equivalent of five, 50 basis point rate hikes from the Fed through to the end of the year, with a decent chance of a 75 basis point hike at the July meeting. The main focus will, however, be on both the path of policy beyond the July meeting and the possibility of a 75 basis point hike at some point in the coming months. The bank’s ‘dot plot’ of interest rate projections will be key. In our view, we are certain to see a material upward shift to the bank’s interest rate projections from the March meeting, which showed the year-end median dot in the 1.75-2.0% range - just one percentage point above current levels. We think that the reaction in the US dollar will depend highly on the extent of this upward revision.