UK: Weekly FX Market Update 22 August

GBP

• UK CPI hit an eye-watering 10.1% on a yearly basis: its highest reading in 40 years.

• More bad news followed with the consumer confidence reading of -44. This is lower than 2008, when the global financial crisis started.

• Liz Truss strengthened her grip on becoming the UK’s next PM.

The pound initially benefited from the inflation number on the rationale that this would trigger a more aggressive stance from the Bank of England on interest rates, the logic being that rising interest rates usually support a currency. However, it is worth noting that the Bank of England starting hiking interest rates in December 2021 when GBP/USD was above 1.3000, and despite 6 consecutive rises from 0.1% to 1.75%, GBP/USD has fallen to below 1.2000, posting lows in the 1.18’s.

The latest polls suggest that the Prime Minister tasked with solving the multiple issues of a recession, stagflation, and a cost of living crisis will be Liz Truss. She has promised tax cuts, and has already started legal proceedings against the European Union over UK access to scientific research programmes. Citigroup called Truss’s tax policy the ‘greatest risk’ to the UK. Trade with the EU is likely not to improve in the wake of legal action.

Next week the market will review the forward-looking Purchasing Managers Index data to try and add a little more colour to the economy’s short-term outlook. However, the medium-term outlook already looks very challenging.

EUR

• As is tradition, August is when Europe goes on holiday and euro volatility declines.

• The euro is trading within a 2% band from high to low against the USD, 1% either side of where the month began.

• This fall in volatility is despite the backdrop of the energy supply issues, which are well publicised to take hold in the coming months, but still appear to be being ignored by the markets.

• Tuesday’s data could hold the key to how the euro performs next week, with Services PMI data and the consumer confidence reading set to be released.

USD

• San Francisco Fed President Daly struck a bullish tone regarding future interest rate hikes in the US, strengthening the dollar across the board as the week closed. In her words “our work is far from done yet” in bringing down inflation.

• The dollar had been struggling to make gains in the last few weeks due to the uncertain nature of how 2023 rate decisions might play out.

• She dispelled the idea that rates might be cut in 2023 due to growth concerns, adding that core services inflation is still rising, and that food, energy, and housing prices are increasing as well.

• Rate hikes may slow or pause if/when inflation is falling, but the message is that the Fed will not cut rates, just after they have been hiked.

This week, the main event is the Jackson Hole Symposium, where the Kansas City Fed hosts central bankers and senior finance officials alike.

Could Fed Chair Powell be as direct as San Francisco Fed President Daly regarding interest rates? If so, could the market embark on another round of USD buying?

RoW

• China’s zero-tolerance policy regarding COVID is playing havoc with its economy, with figures released last week suggesting that the Chinese economy narrowly missed declining in Q2.

• It was later announced that Chinese COVID cases have hit a three-month high, so not only is the current policy not containing COVID, it is also damaging the economy.

• As long as this continues, the hoped-for recovery by the commodity currency economies may well be delayed.

• In accordance with the wishes of President Erdogan, the Turkish central bank cut interest rates from 14% to 13%. Inflation is around 80%.

• It is now possible for USD/TRY to reach a new all-time high above 18.2335, and for the Turkish economy to experience hyperinflation.

Key events for the week

Tue Aug 23

09:00 EUR Flash Manufacturing & Services PMI

09:30 GBP Flash Manufacturing & Services PMI

14:45 USD Flash Manufacturing & Services PMI

15:00 EUR Consumer Confidence

Thu Aug 25

Day 1 Jackson Hole Symposium ‘Reassessing Constraints on the Economy & Policy’

13:30 USD Preliminary GDP

Fri Aug 26

Day 2 Jackson Hole Symposium