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Rate hike hangs in balance as data pours in

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Sterling’s performance last week had something of the Grand Old Duke of York about it.  A relief rally after the Q3 GDP release on Wednesday, showing GDP up a slightly-better-than-expected 0.4% q/q, was sent into sharp reverse on Thursday as the CBI retail sales index recorded a balance of -36 – the worst performance since March 2009. This index is based on only slightly more than a hundred businesses, and is subject to much volatility. As such, it might be expected to be treated with some caution by the markets. However, traders were having none of that line of argument last Thursday and duly marked GBP/USD down a couple of cents to 1.3075 by Friday morning. The situation was not helped by a general feeling of malaise around the Brexit negotiations, or by the growing awareness amongst market participants of the increasing probability of a hard Brexit.  
 
Nonetheless, sterling performed rather better against the euro. The single currency was panned after what the markets took as surprisingly dovish comments from ECB president Mario Draghi; although quite why the markets were so surprised by the ECB’s decision to extend QE until next September, albeit from the end of this year at €30 billion per month (half the current amount), is a mystery. Draghi has always made it clear that policy would remain accommodative for a long time yet, and that rates would remain low for a considerable period even after the end of QE. For good measure, he did add last week that QE might be extended beyond next September, if necessary, or even the monthly amount increased, should economic circumstances dictate.
 
Some more dovish members of the MPC will have breathed a sigh of relief at Draghi’s ongoing commitment to monetary stimulus, since it makes their decision this week a little easier. Had Draghi, despite his previous assurances, committed the ECB to a quicker tapering of QE as a prelude to normalisation of interest rates, MPC members would doubtless have felt themselves under greater pressure to vote for a rate hike this Thursday. Given last week’s dreadful retail sales data, this would have left several members in a quandary. However, with the ECB pursuing a dovish stance, the more dovish MPC members might feel better about delaying a vote for a rate increase. Furthermore, after the last vote of 7-2 against raising rates, three members will have to change their minds this week to tip the balance to 4-5. Interestingly, none of those who would be required to switch and vote for a rise this week has ever voted for a rise before – including Mark Carney. Indeed, such a turnaround could open the MPC to the charge of ‘groupthink’. Nonetheless, the market attaches an 85%+ probability to a rate hike on Thursday - but that looks too high. With such certainty built in, the upside for sterling this week looks much more constrained than the downside in the still reasonably likely event that current expectations of a rate rise are dashed.  
 
Meanwhile, in the US, the first estimate of Q3 GDP came out at 3.0% compared with the same period last year. This is the second quarter running that GDP growth has hit President Trump’s targeted annual rate of 3.0%. The news pushed EUR/USD, already under pressure after Draghi’s comments post-press conference on Thursday, yet lower to close the week at 1.1608 – down from Thursday’s high of 1.1836. With the Fed poised to raise rates in December after a very successful corporate earnings season, and the ECB clearly sticking to the plan of ‘lower for longer’, there seems little to support EUR/USD and an extension of the weakness of the last two trading days seems on the cards. Indeed, the euro was trading so poorly last Friday that even sterling, hampered by the previous day’s retail sales figures and weighed upon by politics, managed to rally against the single currency, with GBP/EUR closing the week just above 1.1300, where it remains at the time of writing.
 
This week is a busy one for data, with Q3 GDP for the eurozone released tomorrow (expected up 2.4% y/y). The eurozone September unemployment rate is also released tomorrow (expected down a notch to 9.0%), while the inflation numbers on the same day will go some way to explaining Draghi’s relative dovishness. The estimate for CPI in October is unchanged at 1.5%, while the core rate is expected to have remained unchanged at a mere 1.1%.
 
At home, GfK’s consumer confidence, also released tomorrow, is expected to have slipped from -9 to -10 in October. It will be interesting to see, after last week’s CBI retail sales data, whether consumer confidence is marked down similarly. UK PMI numbers for manufacturing, construction and services are due tomorrow, Wednesday and Thursday and are expected to come in at 55.9, 48.5 and 53.3 respectively.
 
The most important data releases of the week, however, will be those relating to the US labour market on Friday. Non-farm payrolls are expected to have increased by a healthy 310k in October after September’s -33k, while the unemployment rate is expected to have remained unchanged at 4.2%. Markets will spend the week awaiting these US data and are not expecting any action from the Fed at this week’s FOMC meeting. Indeed, any change to Fed policy before the December meeting, at which another 25 basis point hike is about 85% discounted, would be a complete shock. In the UK, the big surprise would be if Bank Rate were not raised by 25 basis points this Thursday. In that scenario, sterling would look very vulnerable.

 

All views expressed here are the author’s own and are based on information available at the time of writing
 

 

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