After a disappointing start to the week European markets rebounded modestly yesterday, but with all the talk of trade wars and plateauing economic data it is becoming apparent that the momentum seen in January has well and truly dissipated. Momentum indicators are starting to flash warning signs of further declines, while German investor sentiment in March slipped back to an 18-month low.
UK inflation slipped back in February following a trend that we’ve seen in EU and US inflation numbers in recent days. This slide back from 3% to 2.7% and the lowest since last summer, will be a very welcome development for UK policymakers worried about rising prices becoming entrenched.
The pound slipped back in the wake of yesterday’s numbers as the prospects of a rate rise in May slipped a little. This appears on the face of it to be a rather one dimensional and simplistic reaction as the fall in CPI is unlikely on its own to make much difference to the reaction function of the Bank of England.
It does appear that the rise in the pound is now starting to exert downwards pressure on prices with input prices also dropping back, but on the other side of the ledger there does appear to be some evidence of upwards pressure on wages, which could see the gap between wages and prices narrow further.
It has been well established that a number of Bank of England officials are expecting wages to start outstripping headline inflation in the coming months, and a strong average earnings number today could well reinforce that narrative, and raise expectations of a move on rates in May, irrespective of yesterday’s softening in headline CPI.
For the three months to January this is expected to see an increase from 2.5% to 2.6%, while the ILO unemployment rate is expected to remain steady at 4.4%.
With a Brexit transition deal agreed in principle the economic outlook is also likely to remain on a fairly even keel, and as such the prospects for a rise in rates has improved.
Today’s Federal Reserve meeting is likely to see the US central bank raise rates for the fourth time in the last 12 months, pushing the Fed funds rate up 25 basis points to 1.5% to 1.75%.
It will also be new Fed chief Jerome Powell’s first press conference as chairman, and investors will be paying particular attention to the Fed's outlook, in light of recent stock market volatility and rising chatter about the prospect of disruptions in international trade, with President Trump threatening $60bn worth of tariffs on Chinese products at the end of this week.
The Fed statement, due at 6pm (UK time) is likely to be scrutinised closely for any material changes to the economic outlook as well as changes to the tone from January. Let’s not forget the backdrop to the last meeting was fairly benign in terms of stock market volatility, and took place in the aftermath of recent changes in the US tax code.
The backdrop today is far less benign with concerns about trade wars, slowing economic data, political dislocations in Washington DC and some evidence of softer inflation. Any alterations to the economic forecasts could well send a bigger signal than any variation in the dot plot glide path.
EUR/USD – sliding below support at the 1.2250 level with shallower rebounds has the potential to target the 1.2160 area, and even the 1.2000 area. We need to break above 1.2350 to target the 1.2420 level.
GBP/USD – this week’s break above the 1.4000 area appears to be stalling just below the 1.4100 area. To open up further gains towards 1.4250 we need to hold above the 1.3980 area. A move below 1.3970 runs the risk of a return to the lows last week.
EUR/GBP – still seems range bound with support at the 0.8740 area this week, with a break targeting the 0.8690 area. We need to see a move back through 0.8820 to retarget the recent peaks above 0.8920.
USD/JPY – still finding some support between 105.20 and 105.50, but needs to push beyond 107.20 to suggest the base is in and retarget a move back to 108.30.
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