Dollar dips as US inflation cools

Important calendar events

• GBP: GDP, Construction Output, Goods Trade Balance, Index of Services, Industrial Production, Manufacturing Production
• EUR: Industrial Production
• USD: PPI, Core PPI, FOMC Economic Projections, Federal Funds, Rate, FOMC Statement, FOMC Press Conference

USD

The dollar dipped on Tuesday, with the dollar index dropping to 103.3. US Treasury yields surged however, with the US 10-year bond yield touching 3.82%.

Signs of cooling inflation put pressure on the dollar on Tuesday. US Headline inflation dropped sharply to 4.0% year-on-year in May, from 4.9% in April. US Inflation cooled more than expected in May, as markets were anticipating a 4.1% print. Core CPI, on the other hand, which excludes food and energy, remained sticky at 0.4% every month and 5.3% on an annual basis. As headline inflation dropped to its lowest point since March 2021 after 12 consecutive months of declines. Easing inflation enhances the odds of a pause in rate hikes at Wednesday’s Fed meeting.

The U.S. Federal Reserve is holding its next policy meeting on Wednesday. The Federal Reserve raised interest rates by 25 basis points at its latest monetary policy meeting, bringing the benchmark interest rate to a 16-year high target range of 5.00% to 5.25%. 

Markets are pricing in an 80% chance that the Fed will not raise interest rates for the first time in well over a year. Fed officials have signaled that the central bank will forego a rate hike. US Federal Reserve Chair Jerome Powell has also indicated that the US Central Bank may pivot towards a more dovish direction. 

However, the big question right now is, will the Fed stop hiking rates altogether, or just skip a rate hike at the coming meeting? There is growing speculation that, even though the Fed may not raise interest rates on Wednesday, that does not necessarily mean an end to its tightening cycle. The purpose of suspending rate hikes is to give policymakers time to assess the pace of cooling inflation. Many economists believe that the Fed may resume rate hikes as early as July if inflation remains sticky.

The US economy expanded by 1.3% in the first year of 2023 against predictions of a 1.1% growth. The preliminary GDP Price Index, which is an important inflation gauge, exceeded expectations, rising by 4.2% in Q1 of 2023 versus the 4.0% anticipated. 

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EUR

The Euro gained strength against the dollar on Tuesday, with EUR/USD fluctuating and climbing above the 1.080 level. If the currency pair goes up, it may encounter resistance near 1.083. If the EUR/USD pair declines, it may find support at 1.067. 

Economic health indicators released on Tuesday for the Eurozone were overall positive, boosting the Euro. German ZEW Economic Sentiment printed -8.5 in June, against -10.7 in May and-13.4 forecast. EU ZEW Economic Sentiment dropped to -10.0 in June from – 9.4 in May but remained above estimates of -12.1. This is a leading indicator of economic health, and a negative print indicates pessimism. 

The ECB will announce its main refinancing rate this week on the 15th, just a day after the Fed’s interest rate announcement. The ECB raised interest rates by 25 bp at its latest monetary policy meeting, bringing its main refinancing rate to 3.75%. The ECB had raised interest rates by 50 bp in previous meetings and is slowing down the pace of rate hikes. The ECB has left the door open for further rate hikes as inflationary pressures in the EU remain high. 

The ECB is widely expected to hike its benchmark rate by 25 bps at its meeting on Thursday. ECB President Christine Lagarde has warned that inflationary pressures in the Eurozone remain high and that borrowing costs will be raised further to tackle them. Lagarde’s comments point to further rate hikes up ahead, while the US Fed has signaled a pause in rate hikes.

Market participants will follow closely the ECB Monetary Policy Statement and Press Conference after the conclusion of the meeting for hints on the central bank’s future policy direction. Many analysts anticipate that the ECB’s hawkish policy will continue and that the central bank will not signal a pause in its tightening path after Thursday’s meeting.

Headline inflation in the Eurozone cooled to 6.1% year-on-year in May from 7.0% in April, beating expectations of 6.3%. Core Inflation, which excludes food and energy, also slowed to 5.3% annually in May versus 5.6% in April and the 5.5% forecast. The latest inflation print is showing that the ECB’s efforts to bring inflation down are paying off, but it will likely not be sufficient to induce the central bank to abandon its hawkish policy just yet.

GDP data for the first quarter of the year showed that the Eurozone is technically entering a recession. Revised GDP showed a contraction of 0.1% for Q1 of 2023, in contrast to the Flash GDP data released earlier which showed an expansion of 0.1%. Deteriorating economic conditions in the Eurozone may force the ECB to rethink its hawkish monetary policy. 

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GBP

The Sterling gained strength on Tuesday, with GBP/USD rising to 1.262. If the GBP/USD rate goes up, it may encounter resistance near 1.268, while support may be found near 1.236. 

Optimistic UK labor data boosted the Sterling on Tuesday. UK wages grew by 6.5% in the three months to April, beating expectations of a 6.1% increase. UK Unemployment Rate dropped to 3.8% in April from 3.9% previous, against the 4.0% forecast. Claimant Count Change, which represents the change in the number of people claiming unemployment benefits printed -13.6K in May, versus 21.4K forecast, and a 46.7K print in April. 

A climate of political instability pushed the Sterling down on Monday. Former Prime Minister Boris Johnson and two fellow lawmakers resigned over the weekend. The ongoing feud between the former PM and the current PM Rishi Sunak has put pressure on Sterling.

The BOE is expected to increase interest rates in the coming months as it fights to bring inflation down. BOE governor Andrew Bailey has warned that inflation in the UK is persistent and will require further tightening to bring inflation to target. Bailey stated on Tuesday, that inflation is taking longer to come down than anticipated, increasing market odds of future rate hikes.

The BOE raised interest rates by 25 basis points at its latest meeting in May, bringing the bank rate to 4.5%. Market odds are in favor of more BOE rate hikes up ahead and many analysts predict no rate cuts at all within the year. The BOE has been following an aggressively hawkish monetary policy, aiming to bring inflation down. As the US has signaled a pause in rate hikes, BOE interest rates may soon catch up with Fed rates, boosting the Sterling.

Headline inflation in the UK dropped below 10% on an annual basis in April for the first time since August 2022. Inflation in the UK is starting to cool, although not as rapidly as anticipated. Headline inflation rose by 8.7% year-on-year in April from 10.1% in March, surpassing expectations of 8.2%. Core CPI, which excludes food and energy, however, rose to 6.8% on an annual basis in April from 6.2% in March.

The British economy contracted by 0.3% in April, after registering stagnation in March. The International Monetary Fund, however, upgraded the UK’s growth prospects stating that a recession was now unlikely. The IMF had previously forecasted that the British economy will contract by 0.6% this year. 

The UK’s weak economic outlook limits policymakers’ ability to increase interest rates sufficiently to rein in inflation. The British economy is struggling, and policymakers will have to assess how much tightening it can withstand to bring inflation down.

GDP data and other economic indicators on the 14th may provide information on the economic outlook of the US and may cause volatility in the price of the Sterling. 

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JPY

The Yen plummeted on Tuesday and USD/JPY was catapulted above the 140 level. If the USD/JPY pair declines, it may find support near 138.5. If the pair climbs, it may find resistance at 140.5. 

The BOJ is holding its monetary policy meeting this week on Friday, the 16th. The BOJ maintained its dovish monetary policy at the bank’s previous meeting in April. This was the first meeting with the newly-appointed BOJ Governor Kazuo Ueda at the helm. Ueda has stated that monetary policy would remain accommodative until the bank’s 2% inflation target became sustainable. He also predicted that price pressures would fall sharply in the next year.

Japanese policymakers are expected to maintain the bank’s ultra-low interest rates on Friday, keeping the central bank’s refinancing rate at -0.10%. The BOJ is also not expected to make any adjustments to its yield curve control program. The BOJ Monetary Policy Statement and Governor Ueda’s post-meeting news conference are expected to attract traders’ attention. Japanese policymakers may take into account rising inflation rates. Increased price pressures raise the chance of the BOJ upgrading its inflation forecast in July, which may lay the groundwork for a change in policy down the road.

BOJ Core CPI rose to 3.0% year-on-year in April from 2.9% in March. April’s print exceeded expectations of a 2.8% growth, indicating that price pressures in Japan continue to rise. Tokyo Core CPI for April was also hotter than expected, at 3.5% on an annual basis, against expectations of a 3.2% print. Inflation in Japan remains steadily above the BOJ’s 2% target, putting pressure on businesses and households. 

Final GDP data for the first quarter of the year released last week showed that the Japanese economy expanded by 0.7%, against a preliminary GDP print of 0.4%. The GDP data exceeded expectations, alleviating recession concerns for Japan. The final GDP Price Index printed showed a 2.0% annual expansion, versus 1.2% the previous quarter. Japan’s economic recovery increases the odds of a hawkish pivot in BOJ’s monetary policy.

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Written by:
Myrsini Giannouli

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