Last week was remarkable in how little major currencies moved. Nearly all of the major ones ended the week within 0.5% of where they had started, an unusual level of quiescence. The hotter-than-expected consumer inflation report out of the US initially made some waves, and helped the dollar rally modestly. By the end of the week, markets were, however, back assigning an implied 80% chance of a March cut in Federal Reserve rates after a miss in Friday’s producer inflation report. Government bond yields were lower and risk assets rose upwards in response, while the dollar was essentially flat.
This week is relatively quiet in terms of economic data or policy announcements, although there will be an unusual number of ECB and Federal Reserve speeches on tap. The November Eurozone industrial production data on Monday, and December UK inflation on Wednesday, provide the main economic references. Federal Reserve speeches will be particularly critical to see if the central bank continues to push back against market hopes for a March cut in rates and 165 basis points of cuts for the whole of 2024, which still strikes us as way too aggressive.
November GDP surprised to the upside last week, calming concerns over the possibility of a technical recession in Q4. The economy expanded by 0.3% month-on-month, following a contraction of the same magnitude in October. If the latest PMI data is anything to go by, another modest expansion in activity may be on the way in December, which would likely avoid the confirmation of a technical recession once the quarterly data is released in mid-February. The reaction in sterling to the data was subdued, however.
This week’s data will test the Bank of England’s recent hawkishness. In addition to the key December CPI inflation report, we will get November wage and December employment figures. While both wage and inflation numbers are expected to show a downward trend, they are both higher than in the Eurozone or the US. Core inflation is still hovering around 5%, and wages are growing at a near 7% rate, and we will have to see substantial reductions in both before the MPC is comfortable with the start of the cutting cycle.
Economic data out of the Eurozone is not improving and continues to tell a tale of a stalling economy, albeit this has not yet translated into layoffs and employment continues to hold up well. Last week’s retail sales report was slightly stronger-than-expected, although we still saw a more than 1% annual contraction and a fourth quarterly downturn in activity in the past five months.
The hawkishness on display at the European Central Bank’s December meeting is being diluted slowly by dovish noises coming from various members of the Council. This week’s industrial production data for November is expected to be dismal, and more clarity on the ECB’s plans should come from a barrage of ECB officials’ speeches, including president Lagarde on Wednesday. The bank’s latest meeting accounts should also shed some light on the December communications when released on Thursday.
The modest upward surprise in the December CPI report did not sway markets to revise their expectations of a Federal Reserve cut as early as March. The key monthly increase in core prices seems to have stabilised at a level of just below 4%, which is too high for comfort and seems to confirm that the ‘last mile’ of the fight against inflation will be tougher than markets expect. By the end of the week, markets appeared to have almost completely forgotten about this upside beat, instead placing greater emphasis on the soft PPI inflation report, released on Friday.
High-frequency labour market indicators continue to suggest little or no loosening, and the most reliable indicators suggest that wages are growing at an above 5% rate amid solid growth and very tight labour markets. We continue to expect that hopes of a March rate cut will be dashed, and therefore think the dollar will stay well supported against European currencies in the short-term.