Important calendar events
The dollar started to recover on Monday, as markets had time to digest last week’s Fed rate decision and the dollar index climbed to 102.6. Monday was a Bank Holiday in the US and US Treasury yields remained at Friday’s closing levels, with the US 10-year bond yielding 3.77%.
The U.S. Federal Reserve kept its interest rate steady at its policy meeting last week for the first time in well over a year. Fed officials have voted to keep the central bank’s interest rate at a target range of 5.00% to 5.25%.
The Fed has signaled, however, that its tightening cycle is not over yet and that its peak rate might be higher than anticipated. The FOMC policy statement following the conclusion of the meeting was hawkish, hinting at further rate hikes. The purpose of suspending rate hikes is to give policymakers time to assess the pace of cooling inflation and many economists believe that the Fed may resume rate hikes as early as July if inflation remains sticky. The Fed warned that additional firming may be appropriate. US Federal Reserve Chair Jerome Powell has also warned that the labor market remains very tight.
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. US 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.
US Producer Price Index data last week confirmed that US inflation is starting to ease. PPI declined by 0.3% in May, against expectations of a 0.1% drop and a 0.2% growth in April. Annual PPI dropped from 2.3% to 1.1%, while core PPI fell from 3.2% to 2.8% year-on-year, beating estimates of 2.9%.
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.
The Euro traded sideways against the dollar on Monday, with EUR/USD oscillating around the 1.092 level. If the currency pair goes up, it may encounter resistance near 1.093. If the EUR/USD pair declines, it may find support at 1.073.
The ECB raised interest rates by 25-bp last week, bringing its main refinancing rate to 4.00%. The ECB has signaled that further rate hikes are required as inflationary pressures in the EU remain high. The ECB revised its inflation forecasts for 2023, 2024, and 2025 by one-tenth of a percent, to 5.4%, 3.0%, and 2.2%, respectively. Higher inflation projections raised expectations for additional monetary tightening.
ECB President Christine Lagarde delivered a hawkish press conference following the policy meeting, pointing to further rate hikes. Lagarde hinted that another rate hike in July is likely as inflation in the Eurozone is sticky. Lagarde’s comments point to further rate hikes up ahead, while the US Fed has signaled a pause in rate hikes.
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% on an annual basis in May versus 5.6% in April and 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.
The Sterling weakened on Monday ahead of the BOE decision later in the week, with GBP/USD sliding to 1.277. If the GBP/USD rate goes up, it may encounter resistance near 1.285, while support may be found near 1.248.
This week will bring both the UK inflation report on Wednesday and the Bank of England policy meeting on Thursday. 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 a 25-basis point rate hike this week, bringing the Official Bank Rate to 4.75%
The BOE is expected to increase interest rates in the coming months as it fights to bring inflation down. The BOE terminal rate is now priced north of 5.75%, which equates to approximately five additional rate hikes. The BOE has been following an aggressively hawkish monetary policy, aiming to bring inflation down. As the US has paused rate hikes, BOE interest rates may soon catch up with Fed rates, boosting the Sterling.
BOE Governor Andrew Bailey has warned that inflation is taking a lot longer to come down than expected, increasing market odds of future rate hikes. Bailey has also stressed that the British labor market is very tight. Labor shortages have pushed up wage growth, increasing inflationary pressures.
Labor data last week showed that 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.
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. April’s CPI print came in at 8.7% year-on-year. Markets are anticipating that inflation will come down further in May to 8.4% on an annual basis.
This is still much higher than the BOE’s goal of 2% and public confidence in the BOE’s efforts to curb inflation has fallen to its lowest level on record. Wednesday’s inflation print is not likely to influence the rate decision on Thursday but may affect the central bank’s forward guidance.
Britain’s economy expanded by 0.2% month-on-month in April after a contraction of 0.3% in March. GDP grew by 0.1% for the 3-month figure to April pointing to slow growth, and cooling recession concerns.
The USD/JPY remained firm on Monday, touching the 142 level. The currency rate benefitted from Yen’s comparative decline against the dollar. If the USD/JPY pair declines, it may find support near 138.7. If the pair climbs, it may find resistance at 142.2.
The BOJ maintained its ultra-accommodating monetary policy last week and the Yen retreated after the BOJ policy meeting. The BOJ held its short-term interest rate target steady at -0.10% and kept its yield curve control program unchanged. The BOJ signaled it is in no rush to change its dovish stance despite rising inflation rates.
BOJ Governor Kazuo Ueda stated after the meeting that even though price pressures are expected to grow over the next few months, there is high uncertainty about next year's wage growth. Ueda also stressed that more time is needed until the bank’s 2% inflation target became sustainable.
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% annually, against expectations of a 3.2% print. Inflation in Japan remains steadily above the BOJ’s 2% target, putting pressure on businesses and households. National Core CPI data are scheduled to be released on Friday for Japan and may affect the BOJ’s future policy direction.
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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