Last week’s US inflation report once again surprised to the upside. The numbers were not high enough to panic the Federal Reserve, although it seems clear that the disinflationary trend in the US has stalled, with annualised core inflation stuck near the 4% level for now. Treasury rates rebounded, ending the recent dollar sell-off and sending the greenback to the top of the G10 weekly FX performance rankings. Only Latin American currencies, led by a screaming Chilean peso rally, were able to withstand the flight to the dollar. The two top performing major currencies year-to-date are now the Mexican peso and the Peruvian new sol. A litany of central bank announcements will take centre stage this week. Of course, the Federal Reserve meeting on Wednesday is the main focus, but very close behind is the Bank of Japan. We expect the BoJ to begin guiding markets towards higher rates on Tuesday, particularly after the blockbuster wage gains secured by Japanese unions last week – indeed, there is very tangible possibility of a first hike since 2007 this week. The Bank of England meeting on Thursday, by contrast, may be overshadowed as markets expect neither policy changes nor a significant change in stance.

 

GBP

The UK story of relatively resilient demand, sticky inflation and a central bank that is in no hurry to cut rates will be tested by the deluge of data and monetary policy news this week. The CPI report on Wednesday is expected to show a significant drop in both the headline and core indices, and the PMIs of business activity should indicate continued expansion. The inflation data in particular may open the way for a modest dovish shift among MPC members. We don’t necessarily expect the BoE to tweak its statement or guidance, with the committee to again indicate that it will need to see more evidence of a downward trend in inflation and wages before committing to lower rates. We may, however, see a dovish shift in the voting pattern, whereby one, or perhaps both, of the hawks shift their allegiance in favour of no change. This could provide some near-term downside to sterling, although this dovishness already appears largely priced in, and the reaction in the pound may be somewhat less aggressive.

 

EUR

The flash PMIs of business activity for March are the only data points of note in the Eurozone this week, so we expect the common currency to trade mostly off the busier schedules elsewhere, notably Wednesday’s FOMC announcement. Markets are expecting another move higher in the services PMI, with economists eyeing an eight-month high. This should bump up the composite index to just shy of the 50 level that separates expansion from contraction. The general trend towards pricing in later cuts has left just a 75% chance of a June rate reduction from the European Central Bank. We think that this may be too late, however, and it will be difficult for the Governing Council to justify further delays in rate cuts. ECB President Lagarde will be speaking on Wednesday this week, although we do not foresee any real change in her communications relative to the previous policy meeting.

 

USD

The disinflation trend in the US seems to have stalled for now, and markets are focusing on Wednesday’s FOMC meeting to see if inflation stickiness and economic resilience are having an impact on Fed officials’ outlook. Chair Powell will probably largely reiterate his comments from the recent semi-annual testimony to Congress, saying that rate cuts are on the way this year, without committing to easing policy at this stage. One way in which the central bank may communicate this is the ‘dot plot’, in which FOMC members make explicit their forecasts for rates at the end of the coming few years. If this were to change from the three 2024 cuts forecast in December to just two, that would be meaningful news and would likely prompt a sharp dollar rally. While we expect the 2024 dot to remain unchanged, we see a much higher probability of a hawkish shift than a dovish one, so risks to the dollar appear skewed to the upside leading into Wednesday’s announcement.