Sterling rallies as BOE amps up gilt market liquidity

Important calendar events

• JPY: Current Account, Economy Watchers Sentiment
• GBP: Average Earnings Index, Claimant Count Change, Unemployment Rate, MPC Member Cunliffe and BOE Governor Bailey Speeches
• USD: NFIB Small Business Index, IBD/TIPP Economic Optimism, FOMC Member Mester Speech

USD

The dollar gained strength on Monday, as the dollar index climbed back up above 113. US Treasury yields retained the value they had at closing on Friday, as Monday was a Bank Holiday for the US, with the US 10-year bond yielding almost 3.9%.  

The dollar opened strong on Monday, propped up by strong US jobs data released on Friday. Global recession concerns intensified on Monday, boosting the safe-haven dollar at the expense of competing assets. Sharp rate hikes and continuous fiscal tightening run the risk of tipping some of the world’s leading economies into recession. 

Hawkish Fed rhetoric in the past few weeks has been increasing the odds of a steep rate hike at the Fed’s next monetary policy meeting. On Monday, FOMC member Charles Evans stated there was a strong consensus at the Fed to raise its interest rate to around 4.5% by March and hold it there until inflation was under control.

So far, US inflation does not show signs of cooling at the expected rate, despite the Fed’s efforts. Core PCE Price Index, the Fed’s favorite inflation gauge, increased 0.6% month-on-month in August, compared to a forecast of 0.5%, with the annual reading climbing to 4.9%. Inflation in the US remains high, putting pressure on the Fed to maintain its hawkish stance. Odds of another steep rate hike at the Fed’s next policy meeting in November increased, providing support for the dollar.

The US Federal Reserve recently voted to raise its interest rate by 75 basis points to curb soaring US inflation rates. The US Central Bank has increased interest rates by a total of 300 basis points this year, bringing its benchmark interest rate from 2.50% to 3.25%. 

Only minor economic indicators are scheduled to be released on Tuesday, which is not expected to impact the dollar significantly. FOMC Member Mester is due to deliver a speech on Tuesday, which may affect the dollar as Fed rhetoric has been one of the primary drivers of USD price in recent months.

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EUR 

The Euro sunk lower on Monday, with the EUR/USD pair dropping below the 0.970 level and moving to a 20-year low again. If the EUR/USD pair declines, it may find support near the 0.961 level and further down at the 0.845 level representing the 2002 low. If the currency pair goes up, it may encounter resistance at 1.005 and further up at 1.019. 

Escalating Russian hostilities against Ukraine on Monday triggered a risk-aversion sentiment, boosting the safe-haven dollar. Increased Fed rate hike expectations re-ignited global recession concerns, further bolstering the dollar at the expense of riskier assets.

Europe on the other hand is facing an energy crisis, driven by the EU’s dependency on Russian energy. High energy costs in the Eurozone are driving the Euro down, while inflationary pressures mount. 

Eurozone inflation is on the rise, intensifying the EU’s economic crisis. Eurozone inflation reached double digits in September, climbing to 10% on an annual basis, compared to 9.1% in August, beating estimates of 9.7%. Inflation in the EU is expected to rise even further in the following months driven by the high cost of energy in the Eurozone. Increased price pressures are forcing the ECB to take swift action to tackle inflation. 

Soaring EU inflation rates and hawkish ECB rhetoric increase the odds of a 75-bp rate hike at the Bank’s next meeting in October. The Euro has been pushed down by the gap in interest rates with the US. The US Federal Reserve recently voted to raise its interest rate by 75 basis points, bringing its benchmark interest rate to 3.25%. In its latest monetary policy meeting, the ECB raised its benchmark interest rate by 75 basis points as well, but its interest rate is still only 0.75%, putting pressure on the Euro. 

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GBP 

The Sterling rallied on Monday, as the BOE amped up gilt market liquidity. The GBP/USD pair traded sideways, even as the dollar gained strength, fluctuating around the 1.105 level. If the GBP/USD rate goes up, it may encounter resistance near 1.149 and higher up at 1.173, while support may be found at the new all-time low of 1.035. 

The Bank of England announced on Monday that it would increase its gilt market purchase program from a daily maximum limit of GBP5 billion to GBP10 billion for the rest of the week. The BOE had recently announced its bond-buying program, aiming to stem the sell-off in the UK gilt market by buying long-dated gilts, which have been strongly affected by repricing. On Monday, the BoE increased market liquidity ahead of the end of the gilt buying program on Friday. The announcement boosted the Sterling, which had been slipping again in the past few days.

The Sterling has been declining for the past couple of weeks, as the announcement of the first ‘mini-budget’ brought the market’s distrust of the new British government, driving the pound to an all-time low. The budget included major tax cuts, which would primarily benefit the highest earners in a time of heightened economic pressure on British households.  

British Prime Minister Liz Truss defended the budget initially, and the new Government received heavy criticism for some parts of the plan. Last week, however, the British Government made a U-turn, scraping some of the most controversial parts of the mini-budget, and boosting the Sterling.

Recession concerns are also weighing the currency down. The BOE has warned that recession is expected to hit the UK in the fourth quarter of this year, and is forecasted to last for five quarters, until the end of 2024 with GDP falling to 2.1%. 

The Bank of England raised its interest rate by 50 bps in its latest meeting, bringing the total interest rate to 2.25%. The BOE continues to tighten its monetary policy to bring inflation under control, although annual inflation in August dropped to 9.9% from 10.1% in July. The BOE has adopted a moderate stance, trying to strike a balance between battling inflation and supporting the sluggish economy. In contrast, the Fed is ramping up efforts to combat US inflation by raising its interest rate by 75 basis points. 

Important economic indicators are scheduled to be released on Tuesday for the Sterling, such as the Average Earnings Index, Claimant Count Change, and Unemployment Rate. MPC Member Cunliffe and BOE Governor Bailey are due to deliver speeches on Tuesday, which may affect the Sterling.

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JPY

The Yen lost ground against the dollar on Monday, even though Monday was a Bank holiday for both the US and Japan. The USD/JPY pair traded above the 145 thresholds on Monday, reaching as high as 145.7. If the USD/JPY pair falls, support might be found near 141.5 and further down at 138.0. If the pair climbs, it may find further resistance higher up at the 1998 high of 147.7.

The dollar was boosted on Monday by robust US jobs data released on Friday. Hawkish Fed rhetoric on Monday, increased the odds of a Fed rate hike, further supporting the dollar. As the dollar rallied, the USD/JPY traded above the 145 level again, which seems to represent a line in the sand, as the Japanese government rushes to intervene when the currency pair crosses this level. 

The Japanese government intervened last month to stem the Yen's weakness after the currency pair threatened to cross that level. The Japanese Ministry of Finance intervened in the Foreign Exchange market for the first time since 1998, buying Yen for dollars. It remains to be seen whether Japan will continue to defend the 145 level when Japanese markets open again on Tuesday, although the government of Japan cannot sustain such a plan indefinitely. 

On the other hand, the BOJ is unlikely to reverse its dovish policy to aid the struggling Yen. In its latest monetary policy meeting, the BOJ maintained its ultra-easy monetary policy keeping its main refinancing rate at -0.10%. Japan continues to pour money into the economy, while other countries are adopting a tighter fiscal policy. The difference in interest rates with other major Central Banks puts the Yen at a disadvantage, driving its price down. The US Federal Reserve voted to raise its interest rate by 75 basis points last week and the wide difference in interest rates is putting pressure on the Yen.

Several minor economic indicators are scheduled to be released this week for Japan, but these are not expected to have a significant impact on the Yen.

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Written by:
Myrsini Giannouli

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