Published: 25/05/2023 By ECAPSterling is on the back foot with some analysts concerned by the currency's inability to hold a rally following the release of stronger-than-expected UK inflation midweek. Sterlings rally against some of its peers has stalled recently and there are increasing possibilities that the consolidation phase could extend a bit further in the short term. Market participants think that the pound’s most recent price action has been linked to the divergence with UK bond yields. Investors saw the inflation numbers and raised expectations for more Bank of England interest rate hikes over the coming months, with a further three 25-basis point hikes now expected. This prompted a sell-off in domestic bonds and a surge in the yields paid on those bonds. However, the subdued reaction in sterling to the recent data suggests that much of the optimism could well be baked in the price, prompting caution from market participants.
The Euro lost further ground this morning after GDP data released showed that the German economy, the largest in Europe, contracted slightly in the first quarter of 2023 compared with the previous three months, thereby entering recession. The federal statistical agency said the German economy contracted 0.3% in the three months to March, adjusting its initial estimate of zero growth. A second consecutive quarterly decline in GDP - after a downwardly revised 0.5% contraction in the final quarter of last year - meets the definition of a technical recession. Officials at the European Central Bank have tended to point towards further interest rate increases in order to tame inflation, with Governing Council member Bostjan Vasle the latest to do so. However, growth is proving hard to find in the region, and this tone could soon change.
The US dollar gained in the overnight trading session, climbing to a two-month high on rising fears of a US default as Fitch threatens a rating downgrade. The Dollar Index held its gains at 103.95, just below the 104.05 overnight peak, the highest level since mid-March. The dollar’s safe haven status has meant that it has benefited from the lack of progress in the talks to lift the US government's $31.4 trillion debt ceiling, with the early-June deadline that Treasury Secretary Janet Yellen said is when it’s “highly likely” that her department will run out of money drawing nearer. This uncertainty has resulted in ratings agency Fitch putting the United States' prized “AAA” rating on watch for a possible downgrade, adding to the jitters in global markets.