The Bank of England followed the lead of the European Central Bank rather than the US Federal Reserve at its policy meeting on Thursday, pushing back against suggestions that the recent spike in near-term inflation may see it taper its asset purchases programme further in the coming months. While it is questionable what additional benefit QE is providing as a stimulus measure by this point, the central bank is unwilling to back itself into a corner by sending a message to markets that it will begin withdrawing support at this early stage and risk pushing borrowing costs higher. This is a similar situation to the one that governments are facing in relation to easing Covid-19 restrictions – they don’t want to signal all clear and then subsequently have to backtrack as developments play out negatively.
Ultimately, while the economic outlook has improved, risks remain considerable. The Covid-19 crisis has not yet been fully contained and the expiration of the Job Retention Scheme in September is looming on the horizon, with most analysts expecting a sharp rise in unemployment as a result. If these risks fade and inflation remains above target, the central bank knows it can contain price pressures through rate hikes. As a result, the view among MPC members now appears to be that the risk is of doing too little, rather than too much. History affirms this view, with the ECB’s decision to hike rates in response to a spike in oil prices in 2011 – ranked by economists as one of the worst policy mistake in recent history given that it was a contributing factor to the emergence of the Eurozone Debt Crisis – standing out as a warning to overly hawkish central bankers.
As with the ECB, the BoE’s message seems to have been well-understood by markets, with traders slightly rowing back on the timeline for interest rate hike bets in the aftermath of Thursday’s meeting. With the ECB and BoE clearly in pause mode, both central banks have communicated they are expecting a significant increase in inflation in H221 and activity indicators likely to point to strong (albeit easing) growth, the euro and sterling may struggle for direction in the near-term.
There is thus scope for us to slip into a period of relative calm on FX markets more generally in the coming months, though the key wildcard remains the dollar given divisions within the Fed on the appropriate path for policy. The Board of Governors and NY Fed President Williams (who account for 8 of the 12 votes on the FOMC) have generally pushed a more dovish line consistent with the central bank’s new inflation targeting regime. However, this is being undermined by hawkish statements from regional Fed presidents, some of whom are concerned that current inflation will not prove transitory, and policy should be tightened prematurely as a result.
If the central bank’s communications issue means that markets are now trading data as if the Fed has adopted a more data-dependent approach rather than remaining on autopilot, US CPI inflation (July 13) and payrolls figures (this Friday) will represent potential catalysts for swings in the dollar. This risk may prove to be asymmetric, given interest rate futures contracts are already fully pricing in a 25 basis points (bps) Fed rate hike by Q422. By this, we mean that data that prints ahead of expectations will result in only modest gains for the dollar, while significant data misses will pose a considerable downside to the dollar.
The key event for the dollar, and markets generally, is Friday’s US employment report. Employment data have printed on the weak side over the past two months, with non-farm payrolls increasing by an average of 419k vs. prior estimates for a series of 1m+ prints. This is not to say the US economic recovery is a mirage – what is happening is that labour demand is being depressed by enhanced jobless benefits, concerns over the virus and school closures. As a result, we now have an unusual situation where non-farm payrolls are 7.6mn below their pre-pandemic peak (equivalent to the total number of jobs lost following the 08/09 crash), yet wage inflation in certain sectors is taking off amid high levels of labour demand. This in turn is is driving fears of a 1970s style wage-price inflation loop.
Consensus expectations are for a +675k non-farm payroll print in June, though Reuters forecasts range from a low of 400k to a high of 950k. With several traditionally ‘red’ states opting to end enhanced benefits in the month, there is some scope for an upside print. While this in turn should benefit the dollar at the margin, the wide forecast range suggests we may need a significant surprise to prompt any major move in the greenback. It will be interesting to see if a positive surprise is accompanied by an easing of average hourly earnings growth (f’cast +0.4% m-o-m versus +0.5% in May), but the data will be of secondary attention to markets.
Elsewhere in what is a US-centric calendar, the US manufacturing ISM for June shouldn’t be a major mover for the dollar, barring an unexpected and unlikely major downside miss. The data are likely to confirm the message from May’s durable goods orders report and the already released June PMI that the manufacturing sector is continuing to experience rapid growth, but activity is being held back by supply chain disruptions.
There isn’t a huge amount out from a data perspective to influence the sterling this week, though several Bank of England MPC members are down to speak (incl. Governor Bailey on Thursday). After last week’s 8-1 voting decision, the speeches may not offer major direction to sterling as there is little sign of division within the MPC on the appropriate direction for policy. However, as there was no press conference after last week’s policy meeting, it will be interesting to glean any further insights into the central bank’s view on the outlook for inflation and growth.
Eurozone HICP data for June are expected to show a modest easing in the y-o-y rate of headline inflation in June to 1.9%, after oil price-related base effects saw the headline rate hit the ECB’s 2.0% target in May. With the re-opening process accelerating in Europe in June, the risks to the forecast are tilted firmly to the upside. Overall, it’s difficult to see the data having a major impact on the euro, given Lagarde and Co have spent the past month preaching their dovish credentials to all who will listen. Whether this messaging will hold over H221, when German inflation may hit 4.0% y-o-y on the back of base effects associated with the reversal of a VAT cut, remains to be seen.
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