Important calendar events
The dollar retreated on Wednesday, with the dollar index dropping to the 102.3 level. US treasury yields gained strength, with the US 10-year bond yielding approximately 4.03%.
US inflation data are the most highly anticipated fundamentals this coming week. This week's CPI data on Thursday and PPI data on Friday are likely to affect the Fed’s future interest rate decisions.
The Fed’s hawkish stance over the past year has been paying off and US price pressures are cooling. Headline inflation rose by 3.1% year-on-year in November easing slightly from a 3.2% print in October. CPI rose by only 0.1% in November, while Core CPI, which excludes food and energy, rose by 0.3%.
Core PCE price index rose by only 0.1% in November from a 0.2% growth in October against a 0.2% growth expected, bringing the annual rate to 3.2% from 3.4%. This is the Federal Reserve’s preferred inflation gauge and November’s print confirms that price pressures in the US are easing.
The Fed kept interest rates unchanged at its December meeting, within a target range of 5.25% to 5.50%. The Federal Reserve kept its policy settings unchanged at its latest meeting in December but showed signs of a dovish pivot. The FOMC statement emphasized that inflationary pressures in the US are easing, while economic growth remains limited. The Fed’s forward guidance was more dovish than expected, hinting that the central bank is preparing to pivot to a less restrictive monetary policy.
Market expectations of future rate cuts are driving the dollar down, as markets are currently pricing in a 25 bp rate cut in March with over 60% probability.
US Final GDP data showed that the US economy expanded by 4.9% in the third quarter of 2023. The US economy continues to expand, although growth was more modest than anticipated in Q3. Low economic growth may induce the Federal Reserve to pivot to a less restrictive monetary policy. Final GDP Price Index for the first quarter of the year was also revised lower, with a final print of 3.3% versus 3.6%. This is an indicator of inflation, and a lower print indicates cooling price pressures in the US.
The Euro gained strength against the dollar on Wednesday and EUR/USD climbed to the 1.097 level. If the EUR/USD pair declines, it may find support at 1.088, while resistance may be encountered near 1.100.
Economic activity data released for the Eurozone this week were mixed. German industrial production dropped by 0.7% in November, falling short of expectations for 0.4% growth. This marks the sixth consecutive monthly decline, following a 0.3% drop in October. French Trade Balance remained negative in November, indicating that fewer goods were exported than imported. The difference in the value of imports versus exports, however, was smaller than anticipated, pointing to an improved economic outlook. EU Unemployment rate dropped to 6.4% in November from 6.5% in October against expectations of a 6.5% print.
The ECB’s efforts to curb inflation rates are paying off, even due to decreased economic growth. Price pressures in the EU are cooling and this will likely play a decisive role in the ECB’s future policy.
Final EU CPI data showed that headline inflation in the Eurozone dropped to 2.4% year-on-year in November, its lowest level since July 2021, from 2.9% in October. Final Core CPI, which excludes food and energy, eased to 3.6% year-on-year in November from 4.2% in October. Flash CPI data for December released last week though, showed that the ECB has still some ground to cover to ensure that inflation in the Euro area drops sustainably. EU Flash CPI for December came at 2.9% year-on-year from 2.4% in November. Core Flash CPI for December, however, receded a little, dropping to 3.4% from a 3.6% print in November.
ECB policymakers voted to keep interest rates unchanged at 4.50% in December. The ECB seems to have reached its rate ceiling, as the fragile Eurozone economy cannot withstand further tightening. Markets are starting to price in rate cuts in March, although ECB officials have stressed that discussions on a rate cut timeline have not started yet.
The ECB’s policy is starting to diverge from that of the Federal Reserve. At its latest policy meeting last week, the Fed signaled that interest rates would go down in 2024. ECB President Christine Lagarde, however, has stated that it is too early to talk about rate cuts. Lagarde stressed that interest rates will remain at sufficiently restrictive levels for as long as necessary to bring inflation back to the ECB’s 2% target.
The economic outlook of the Eurozone is deteriorating, however, and may force the ECB to pivot to a more dovish policy. The Eurozone economy does not show signs of recovery and is on the brink of recession. Revised GDP for the Euro area showed that the Eurozone economy contracted by 0.1% in the third quarter of the year, which was in line with expectations. The Eurozone economy barely expanded in the second quarter by 0.1%, after contracting by 0.1% in Q1 of 2023. Year-on-year the EU economy registered stagnation with GDP flat at 0%. The Eurozone economy is struggling and cannot withstand much further tightening.
The Sterling gained strength against the rivaling dollar on Wednesday and GBP/USD rose to the 1.273 level. If the GBP/USD rate goes up, it may encounter resistance near 1.282, while support may be found near 1.260.
BRC Retail Sales Monitor data released on Tuesday showed that retail sales in the UK are dropping. Retail sales rose by only 1.9% in December against a 2.6% growth in November and a 2.3% growth anticipated.
The BOE maintained its official rate at 5.25% at its latest policy meeting, which was in line with expectations. The central bank’s outlook remains hawkish, however, with three policy members voting to increase interest rates versus six members voting to maintain current rates.
BOE Governor Andrew Bailey has kept his hawkish stance, stressing that inflationary pressures in the UK remain high and that further tightening might be required to bring inflation down to the bank’s 2% target.
Bailey testified on Wednesday on the Financial Stability Report before the Treasury Select Committee, in London. Bailey avoided commenting directly on the BOE’s monetary policy outlook but stressed the need to bring British inflation down to target. Bailey also commented on the drop in housing mortgages, stating that he hoped that the recent fall in the cost of mortgages would continue.
The BOE has likely reached its rate ceiling but will keep interest rates on hold for a long time to bring inflation down. Even though the current restrictive policy is hurting economic growth, the BOE has no choice but to continue its battle against inflation.
Market expectations of the BOE’s future direction reflect the need to keep interest rates in restrictive territory for longer. The BOE policy is starting to diverge from that of the FED, with market odds in favor of Fed rate cuts starting in March, but BOE rate cuts are not expected before May.
British inflation cooled more than expected in November, dropping to 2-year lows. Headline inflation slowed to 3.9% year-on-year in November, from 4.6% in October against expectations of a 4.4% print. Annual Core CPI, which excludes food and energy, grew by only 5.1% in November versus 5.7% in October and 5.6% forecast.
Inflation in the UK has been resisting the BOE’s efforts to bring it down for a long time but has been dropping at a rapid pace since October. Signs of easing inflationary pressures in the UK reinforce expectations that the Bank of England will end its hiking cycle and cut interest rates by mid-2024.
The British economy remains fragile, reinforcing the notion that the BOE has reached its peak interest rates. Prolonged tightening has taken its toll on the labor market and other vital economic sectors. Final GDP data revealed that the British economy contracted by 0.1% in the third quarter of 2023, against expectations of stagnation. The British economy expanded by 0.3% in the first quarter of the year and 0.2% in the second quarter. Monthly GDP data showed that the British economy contracted by 0.3% in October. Economic growth is slowing down in the UK and the country is entering a recession.
USD/JPY extended gains on Wednesday, as the Yen’s decline was bigger than the dollar’s, and the currency rate rose to the 145.7 level. If the USD/JPY pair declines, it may find support near 140.6. If the pair climbs, it may find resistance near 146.5.
Weak Japanese labor data on Wednesday put pressure on the Yen. Wages in Japan rose by only 0.2% in November against expectations of a 1.5% growth. Inflation-adjusted wages dropped by 3% year-on-year in November, after falling 2.3% in October.
Inflation in Japan has remained above the BOJ’s 2% target for more than a year, encouraging the BOJ to tighten its monetary policy. Tokyo Core CPI dropped slightly to 2.1% in December from 2.3% in November. National Core CPI cooled to 2.5% year-on-year in November from 2.9% in October print. BOJ Core CPI dropped to 3.0% year-on-year in October from 3.4% in September, against expectations of a 3.4% print.
The BOJ has been keeping interest rates at a negative level, putting pressure on the Yen. The BOJ kept its policy settings unchanged at its December meeting. The central bank kept its short rate target steady at -0.10% and its yield curve control unchanged. The BOJ has also stated that it would reduce the amount of bonds it buys in its regular operations in the January-March quarter.
The BOJ’s forward guidance into 2024 was more dovish than expected, putting pressure on the Yen. In the past few months, BOJ policymakers have hinted that the central bank is preparing to pivot to a less accommodating policy. BOJ Governor Kazuo Ueda, however, has kept a dovish stance in the past few weeks, indicating that a policy pivot is not on the cards yet. Ueda stated that economic growth remains modest and that underlying inflation will gradually increase, but the BOJ requires sustainable, stable inflation before tightening its monetary policy.
The Fed has signaled a dovish pivot, relieving some of the pressure on the Yen, which has been weakened by the BOJ’s dovish policy. The BOJ has so far maintained its dovish bias, putting more pressure on the Yen as other major central banks, and especially the Fed, have raised interest rates to high levels.
Final GDP data for the third quarter of the year showed that Japan's economy contracted by 0.5% in the third quarter against earlier estimates of a 0.5% contraction. The Japanese economy expanded by 1.2% in the second quarter of 2023, showing that the country’s economy is shrinking and is on the brink of recession. Final GDP Price Index showed a 5.3% annual expansion in Q2, versus 3.5% the previous quarter. This is a measure of inflation, which shows that inflationary pressures are rising in Japan, increasing the odds of a hawkish shift in the BOJ’s policy.
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Written by:
Myrsini Giannouli
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