Last week’s currency rankings had an unusual couple on top: the Chinese yuan and the Swiss franc. The former was buoyed by the increasing signs that China is moving away from its zero-covid lockdown policy, whereas the latter appears to have finally caught a break after a few weeks of improving risk sentiment, as traders brace for another outsized interest rate hike from the Swiss National Bank this week. Moves in currencies and financial markets in general were, however, rather subdued as traders marked time ahead of this week’s avalanche of central policy news. The Federal Reserve, European Central Bank and Bank of England will all hold their last policy meetings of the year in a period of fewer than 24 hours on Wednesday and Thursday. All three are once again set to deliver sizable rate increases, although we expect to see a moderation in the size of these hikes, with 50 basis point moves priced in across the board. In addition, the US and UK inflation numbers for November both come out just before their respective central bank meetings. The potential for a surprise either way in those reports that upset the narratives just before the meetings is an underappreciated risk, we think. Either way, get ready for some serious volatility in currency markets this week, particularly surrounding the aforementioned central bank announcements.
Sterling eked out yet another weekly gain last week against both the euro and the dollar, in a week almost completely lacking in major news, confirming that for now the path of least resistance for the pound is up. The pound was buoyed further this morning by strong GDP data for October, which showed a surprise expansion (+0.5%). The Bank of England meeting is now in sight and we, like everyone else, expect the MPC to raise the bank rate by another 50bps. The key will be the expected split within the MPC, i.e., how many members express a hawkish dissent in favour of a 75bp move and how many do so for a dovish 25bp hike. We think that an unprecedented four-way split is not out of the question either, with Silvana Tenreyro indicating recently that she could vote in favour of no change. The publication of key labour market and inflation data in the days leading up to the meeting do, however, make forecasting this week’s meeting an unusually difficult one.
After an unusually quiet week in the Eurozone, all eyes turn to the December meeting of the ECB on Thursday. We expect the central bank to raise rates by 50bps, in line with consensus. We do, however, think that the gap between minimal market expectations for future hikes and economic reality is large, and we expect the communications from the ECB to push in a hawkish direction. The staff projections have (again) underestimated inflation, so we expect these to (again) be revised substantially higher, though (again) somehow future inflation will be expected to converge to the ECB target. However, the changes may not be dramatic and given the ECB’s track record, it is not clear whether anyone pays attention to these anymore. Their impact could, therefore, be relatively muted. Overall, euro trading will depend as much, or more, on events across the Atlantic, particularly given the key inflation report will also be released out of the US.
The unusual juxtaposition between the November CPI release on Tuesday and the Fed meeting the next day will make for very volatile trading this week. The market is expecting a relatively mild outcome in the monthly number of less than 4% annualised inflation for both the headline and the core measures. An upside surprise here may be more upsetting than a downward one, as it would make it more difficult for the Fed to pivot towards a wait-and-see policy the next day. As for the Fed meeting, perhaps the key outcome will be the terminal rate that FOMC members expect to see in 2023, represented by the bank’s famous ‘dot plot’. Anything north of 5% could upend the positive narrative of the last few weeks and provide some headwinds for the US dollar.