hawkish repricing

GBP: Another inflation surprise UK inflation surprised on the upside again in May. Core CPI unexpectedly rose from 6.8% to 7.1%, while the headline rate was unchanged at 8.7% despite consensus expecting a decline to 8.4%. The reason for higher prices is in no small part because of outperformance in services inflation. This will likely concern the Bank of England hawks, and while the chances of a 50bp hike tomorrow still appear limited, this will probably encourage MPC members not to push back against the very aggressive market pricing for further Bank of England tightening. More in our BoE meeting preview. The FX impact of the CPI surprise was interesting. Sterling jumped but then rapidly erased gains: this probably signals how the room for a further hawkish repricing in the Sonia curve is limited and so are the positive implications for sterling of more data surprises.

EUR: Could trade above 1.10, but a correction looks more likely EUR/USD will have the chance to break above 1.10 this week, although we struggle to see the pair trade sustainably above that benchmark level just yet. The gap between market pricing on Fed tightening and the FOMC dot plot continues to leave room for hawkish repricing, while the EUR curve fully prices in two more hikes in the eurozone. Indeed, the OIS curve shows the September meeting has 38bp priced in and more upside surprises and/or hawkish ECB commentary could help markets fully price in a hike in September – but there is currently a smaller gap between markets and central bank communication in the eurozone compared to the US. Our short-term financial fair value model shows that EUR/USD should be trading around 1.0800 based on current market conditions. As mentioned in the dollar section above, the dollar still needs to catch up with the rise in USD rates and that can prove to be a hurdle when attempting a decisive break above 1.10. On the euro side, markets will watch the ZEW index this week after a long series of disappointing forward-looking indicators in the eurozone. On Thursday, the European Central Bank (ECB) minutes from the June meeting will be published. We expect mostly USD-driven moves in EUR/USD this week, and see a greater risk of some pull-back towards 1.0800 rather than trading sustainably above 1.1000 – which could however be possible should US CPI surprise on the soft side.

AUD: Stronger than expected employment gains The Aussie dollar is trading on the strong side this morning after a stronger-than-expected August jobs report in Australia. Employment rose 64.9k after July’s negative reading, and the unemployment rate was unchanged at 3.7%. As explained by our economist in this note, the hiring spike was almost entirely related to part-time jobs. Still, some of those jobs will become full-time in the coming months, which can also push wages higher. We remain reluctant to pencil out another hike by the Reserve Bank from our forecasts, and still narrowly favour one last rate increase to 4.35% by year-end. The new Governor, Michele Bullock, may want to convey the message she is serious about bringing inflation down, and if inflationary pressures show some resilience, she could deliver a final hike at one of the three remaining meetings of 2023. Markets are pricing in a mere 9bp of tightening to the peak, even after the strong jobs figures, meaning there is ample room for a hawkish repricing and AUD to benefit from it. Still, the USD/US activity data story remains much more important for AUD/USD, and we see the pair being capped below 0.6500 for the remainder of September as the USD remains supported post-Fed.  

GBP: Eyes on inflation this week This week, the focus in the UK will be on CPI data for November out on Wednesday. As usual, we'll be paying attention to services inflation, which we estimate to come in at 6.6%, showing little near-term progress. That may help markets ease some of the rate cut bets in the UK and help the pound. Markets are still pricing in four rate cuts by the Bank of England this week despite the Bank’s attempt to discourage dovish bets via in-meeting communication. We still think services inflation in the UK will ease to around 4% by next summer, allowing the BoE to start cutting, but the pound has decent room to benefit from some hawkish repricing in the short run. Last week’s 0.8550 lows in EUR/GBP may well be retested by the end of December.

FX Daily: Not too hot to handle Rate expectations were not moved by slightly hotter-than-expected US CPI, and support for the dollar has mostly come through the risk-sentiment channel. Range-bound trading may persist despite conditions for a stronger dollar. Inflation in the CEE region is falling; the NBR leaves rates unchanged.   USD: Markets still attached to March cut US CPI data came in a bit hotter than expected yesterday, with the core rate rising 0.3% MoM and slowing to 3.9% YoY versus 3.8% consensus. The upside surprise in headline inflation was bigger: an acceleration from 3.1% to 3.4% YoY versus the 3.2% consensus. The dollar jumped after the release, also thanks to weekly jobless claims printing lower than expected. Somewhat surprisingly, the US yield curve did not react by scaling back rate cut expectations, as a knee-jerk selloff in 2-year Treasuries was fully unwound within an hour of the CPI release. We've already discussed how we did not expect this inflation read to leave a long-lasting impact on markets, and it definitely appears that most of the fixed-income investor community is almost overlooking the release. The support to the dollar appears mostly tied to the negative response in equities, given the neutral impact on short-dated US yields. A March rate cut is still over 60% priced in, and we still see short-term vulnerability for risk assets from a hawkish repricing. The conditions for a higher dollar this month are surely there, but we have observed numerous indications that markets remain reluctant to make short-term USD bullish positions coexist with the longer-lasting view that US rates will take the dollar structurally lower by year-end. The chances of rangebound trading until we receive clearer messages by activity data and the Fed are high. Today, PPI figures for December will be released, adding information about lingering price pressures and potentially steering the market a bit more. On the Fed front, we’ll hear from hawk Neel Kashakari.