Bank of England in focus, as Fed stays neutral

CMC Markets

Yesterday offered a welcome respite for equity markets after a raft of economic data showed that the global manufacturing sector performed up to expectations in January. Some decent numbers from China, as well as Europe, the UK and the US helped generate an air of optimism in spite of the recent Trump inspired turmoil, as markets got off to a fairly positive start to the month.

A bumper US ADP private payrolls report also raised expectations of a decent US jobs report tomorrow, even though market reaction to it was fairly muted, probably due to the proximity of last nights Fed meeting.

The US dollar and the pound have been the prime movers on the currency markets in recent days, with the pound starting to look as if it might well be poised to break out to the upside, despite MP’s granting the Prime Minister her mandate to trigger Article 50 in March.

For several months now it’s been difficult to find anyone with a good word to say about the pound, with predictions of moves to $1.15 and $1.10, and it’s usually in those moments that sometimes it pays to take the other side. While doing this does have its risks history does tend to favour a spring rebound in the aftermath of large scale falls. It happened in 1993 and in 2008 when the pound rallied strongly after being battered lower for months on end.

Another thing helping keep the pound afloat is the weakness in the US dollar which came under pressure again yesterday after the US Federal Reserve voted to keep rates unchanged. While this wasn’t a surprise there also wasn’t any discernible shift in tone from the statement in December, which would indicate that the prospect of a March move on rates is not on the table at this time.

This in turn would suggest that it is unlikely that we will see any more than two rate rises this year, with the earliest one not coming before June, which would also help explain why the US dollar is struggling to get back above the 100.00 level on the US dollar index.

Having seen the back of the first US Federal Reserve meeting of 2017 with little in the way of fuss and drama today’s focus shifts to the Bank of England and the quarterly inflation report due later today.

The continued resilience of the UK economy has continued to confound expectations though there are increasing concerns about the impact that rapidly rising prices might have on the economy in the coming months, and in particular on the services part of the economy, which tends to be more price sensitive.

It would be the ultimate irony if the Bank of England’s hasty actions in August had helped to hasten this squeeze on consumers. Yesterday’s manufacturing survey for January was once again encouraging, however input and output costs appear to be putting significant upward pressure on prices with sharp rises in the costs of oil, plastics and steel.

It was nonetheless an encouraging start to the year and expectations surrounding the latest construction PMI for January is also positive with expectations for a slight slowdown to 53.9, from 54.2.

Input prices here are also expected to be the main focus, and it is in this context that today’s inflation report should be viewed. The Bank of England will, in all likelihood, revise upward its growth and inflation forecasts from the November meeting, and while we know that there will be some tolerance for higher prices, recent commentary would suggest that this tolerance might have its limits.

With 5 year inflation expectations currently at 3.6% and UK gilt yields just below 1.5%, we can expect to see this gap to close, which means we can probably expect to see yields push higher, which in turn could boost the pound.

EURUSD – the euro continues to find the air a little thin above the 1.0800 area. We have resistance at the December highs at 1.0875. While above the 50 day MA at 1.0580 the risk is for a potential move through 1.0850 towards the 1.1000 area.

GBPUSD – retested the previous highs above 1.2675, keeping alive the prospect of a move towards the December highs at 1.2795/1.2800. The 1.2410 area, and 50 day MA, remains a key support with the 1.2520 level also a key pivot. A move below 1.2400 would argue for a return to the 1.2250 area.

EURGBP – the failure to move through the 0.8650 area keeps the onus on the downside for now having broken back below the 0.8570/80 area, which now becomes resistance again. A move through the 0.8470 area argues for a move back towards 0.8300.

USDJPY – the US dollar currently trading between resistance at the 114.30 level and longer term support around the 112.50 area. To stabilise we need to get back above the 114.30 area or run the risk of a deeper move towards 111.50.

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