Sterling gains strength ahead of BOE meeting

Important calendar events

• EUR: Final CPI and Core CPI, German ZEW Economic Sentiment, EU ZEW Economic Sentiment
• USD: Retail Sales, Core Retail Sales, Industrial Production, Capacity Utilization Rate Business Inventories, TIC Long-Term Purchases

USD

The dollar slipped on Monday and the dollar index dropped to 105.3. US treasury yields edged higher, however, providing support for the dollar with the US 10-year bond yield yielding 4.28%.

One of the key factors that are driving the dollar right now is the US rate outlook. As expected, the US Federal Reserve kept interest rates unchanged at its policy meeting last week, within a target range of 5.25% to 5.50%. The US Federal Reserve has held interest rates steady since last July. 

Fed chair Jerome Powell reiterated last week that more evidence of cooling inflation is required before a policy change can be considered. Powell stated that the disinflation was slow in the first quarter of the year, resulting in a delay in rate cuts.

Odds of a rate cut in September dropped from 70% to 60% on Monday, as markets had time to digest the Fed’s message. The uncertainty around Fed rate expectations will likely continue in the coming months causing volatility in Forex markets.  

The Fed’s latest dot plot, which is revised every three months, was also released last week. This is the summary of the central bank’s economic projections and was updated to take into account recent inflation and economic data and to provide estimates of the Fed’s interest rate outlook. According to the central bank’s revised dot plot, Fed officials expect to cut interest rates only once in 2024. 

US CPI data for May showed that disinflation in the US is finally progressing. Monthly inflation remained the same in May, after rising by 0.3% in April and against expectations of a 0.1% rise. Headline inflation eased to 3.3% year-on-year in May from 3.4% in April, dropping below expectations of a 3.4% print. Core inflation, which excludes food and energy, rose by just 0.2% in May versus 0.3% anticipated. Annual Core CPI came in at 3.4% versus 3.6% expected, its lowest reading in three years.

The US economy expanded by just 1.3% in the first quarter of the year falling considerably below the 3.4% expansion registered in Q4 of 2023. The US economy is expanding at an increasingly slower pace putting pressure on the dollar, as GDP data have shown expansion by 4.9% in the third quarter of 2023. In addition, the Preliminary GDP Price Index rose by just 3.0% in Q1, which represents a downward revision of 0.1% from the previous estimate.

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EUR 

The Euro benefitted from the dollar’s weakness on Monday and EUR/USD rose to 1.073. If the EUR/USD pair declines, it may find support at 1.066, while resistance may be encountered near 1.085.

The ECB lowered its Main Refinancing Rate by 25 basis points to 4.25% in June. Eurozone inflation remains sticky and may slow down the pace of future rate cuts. ECB President Christine Lagarde has stated that the central bank’s policy will remain data-driven. 

The Euro has been under pressure since political turmoil in France led to the announcement of national elections last week. French President Emmanuel Macron has decided to dissolve the parliament and announce a snap election on the 30th of June, putting pressure on the Euro. 

On the data front, headline inflation in the Euro Area accelerated to 2.6% year-on-year in May up from 2.4% in April and exceeding the forecast of 2.5%. Core CPI, which excludes food and energy, rose to 2.9% on an annual basis in May from 2.7% in April against expectations of a 2.7% print. Inflationary pressures in the Eurozone are not easing as fast as anticipated, which might hold up the ECB’s plans to lower interest rates.

The Eurozone economy expanded by 0.3% in the first quarter of the year, which was in line with preliminary estimates. GDP data for Q4 of 2023 showed that the Euro area economy was stagnant with a GDP print of zero. The EU economy contracted by 0.1% in the third quarter of 2023 and barely expanded in the second quarter by 0.1%, after contracting by 0.1% in Q1. 

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GBP 

The Sterling gained strength on Monday ahead of the BOE policy meeting later this week and GBP/USD rose to the 1.270 level. If the GBP/USD rate goes up, it may encounter resistance near 1.286, while support may be found near 1.265. 

In the coming weeks, we expect to see high volatility in the price of the sterling especially ahead of the UK elections in July.

This week markets will focus on the BOE policy meeting on the 20th. The BOE is not expected to start cutting interest rates this week even though prolonged tightening has taken its toll on the economy.

The BOE kept interest rates steady at its latest monetary policy meeting. The BOE maintained its official rate at 5.25% but showed signs of preparing for a dovish pivot. 

Currently market odds of a BOE rate cut at June’s policy meeting next week are very low and even a rate cut in August is considered unlikely. Markets are pricing in a rate cut in September with approximately 75% probability, while a rate cut by November is fully priced in. Rate cut expectations have shifted from two rate cuts and a total of 50 basis points of rate cuts in 2024 to approximately 35 bp reduction in rates within the year. This week traders will focus on the BOE forward guidance for hints on the central bank’s rate outlook.

The British economy remains fragile and may force the BOE to pivot to a more dovish policy. The British economy remained stagnant in April after expanding by 0.4% in March. The UK slipped into recession last year as the economy contracted by 0.3% in the final quarter of 2023. 

Inflationary pressures in the UK are not easing as fast as anticipated reducing expectations of BOE rate cuts. British headline inflation eased to 2.3% in April on an annual basis from 3.2% in March from 3.4%, exceeding expectations, however, of a more drastic drop to 2.1%. Annual Core CPI, which excludes food and energy, fell to 3.9% in April from 4.2% in March, again surpassing expectations of a 3.6% print. 

The BOE had updated its inflation outlook earlier this year, predicting that inflation would drop to the BOE’s 2% target in the second quarter of the year. The BOE’s forecasts were not confirmed, however, which may force BOE policymakers to keep interest rates at restrictive levels for longer. 

This week, British CPI data for May are due on Wednesday, just a day before the BOE policy meeting. May’s inflation print may potentially affect MPC members’ voting on Thursday.

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JPY

The Yen weakened and continued to decline on Monday and the USD/JPY edged higher, rising to the 158 level. If the USD/JPY pair declines, it may find support near 154.5. If the pair climbs, it may find resistance near 158.2.

The BOJ kept interest rates steady at its policy meeting last week. Reports that the central bank would consider slowing its bond purchases had boosted the Yen ahead of the BOJ meeting. 

The BOJ, however, kept all policy settings unchanged last week. The BOJ had pivoted to a more hawkish policy at its meeting in March, ending its negative interest rate policy and raising the benchmark interest rate into the 0% - 0.1% range. The Yen continues to weaken as there is still a significant disparity between interest rates offered by the BOJ and those from other major central banks. 

BOJ Governor Kazuo Ueda hinted that the central bank would ease its bond purchasing at the next meeting in July. BOJ officials, however, have not given any specifics for paring back their bond-buying program. Market expectations of a hawkish shift were disappointed after the BOJ policy meeting, putting pressure on the Yen. 

BOJ officials attempted to boost the Yen over the weekend, with BOE Governor Kazuo Ueda warning that he is looking at Forex levels and their impact on import prices. Threats of an intervention to support the Yen, however, did not have a significant impact on markets and the currency continued to decline. 

On the data front, inflation in Japan remains weak. Headline inflation dropped to 2.2% year-on-year in April from 2.6% in March. BOJ Core CPI dropped to 1.8% on an annual basis in April, falling short of expectations of 2.2%. Low inflation in Japan is preventing the BOJ from raising interest rates putting pressure on the Yen.

Preliminary GDP data for Q1 of 2024 for Japan showed that the country has slipped into recession. Japan’s economy shrank by 0.5% in the first quarter of the year against expectations of a 0.3% drop. Japan’s economy registered a small expansion by 0.1% in the final quarter of 2023, showing that the country’s economy is shrinking. Recession concerns limit the odds of a BOJ hawkish pivot in the coming months.

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Written by:
Myrsini Giannouli

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