USD in the doldrums as inflationary pressures fade away
Even though central banks’ meetings took centre stage yesterday, investors were also keeping an eye on key economic data from the US. The August inflation report was released yesterday and came in slightly below market expectations. Headline inflation eased to 2.7%y/y versus forecast of 2.8% and 2.9% in the previous month. The surprise came from the core measure as inflation excluding food and energy components printed at 2.2%y/y versus 2.4% expected (and previous month read).
The market reaction was quite strong; especially as investors didn’t pay much attention to economic data lately and rather focus on the US-China trade conflict. EUR/USD jumped 0.75% to 1.17, the highest level since August 27, and continued to grind higher on Friday morning. Similarly, the dollar index fell further as it returned to 94.40, down more than 1% on the week.
Another batch of key data is due today. August’s retail sales are expected to have risen 0.4%m/m (versus 0.5% in July), while the core measure, which excludes auto sales, should come in at 0.5%m/m, down from 0.6% in the previous. Finally, industrial production is forecast to have risen 0.3%m/m, compared to 0.1% a month earlier. Overall, we believe that the risk is biased to the downside for the greenback as a downside surprise could force the Fed to take a break in monetary tightening. With the ECB expected to phase out easy money, it could only push EUR/USD to the upside. Nevertheless, given the uncertainty generated by Turkey, the new Italian government and the Brexit negotiations, it may take longer for the single currency to benefit from this major change.
ECB and BoE maintain key rates unchanged while CBRT surprises the market
Yesterday central banks’ schedule was quite packed. Starting with the Turkish central bank decision to raise interest rates to 24%, a rise of 625 bps, while investors were expecting that the CBTR would target 21%. Unsurprisingly, both the BoE and the ECB maintained their benchmark interest rates unchanged at 0.75% and -0.40%, respectively. The tone did not fundamentally changed for both.
Indeed, BoE Governor Mark Carney confirmed his readiness to support the Sterling at all costs using rate hikes in the case of a no-deal scenario related to EU – UK Brexit talks, a major impediment for UK central bankers. However, although UK economic growth remains above average, would it be enough for the UK economy to support the burden of higher interest rates on the real economy? A recent survey of UK-based companies confirms that 40% of the companies are expecting a sharp drop in exports after Brexit deal – so the consequences of higher interest rates, engendering a higher British pound would most probably not be supportive, which should ultimately not weigh in favor of a stronger GBP for now.
The ECB, took the surprising decision to maintain its QE program after December 2018, reducing by half the volume of monthly bond purchases starting in October to EUR 15 billion. The general outlook remains in line – with a slightly lower growth and inflation outlook (2018: 2% and 1.70% respectively), while risks of protectionism and EM markets collapse is growing. Key interest rates are not expected to change by Summer 2019.
The Turkish central bank confirmed its willingness to defend its currency and it actually worked for now. The USD/TRY pair returned back below 6.25 – for one day at least. The currency trend is reversing back, as investors seem to have doubts about the CBRT independence from its President Erdogan. Short-term we expect a rise in USD/TRY, heading along 6.25.
