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Conditions Set for a Rate Rise; Will the Treasury Select Committee Indicate a Path Set to Tread?

Last week there were signs from the UK economy that there could be further increases in interest rates. The Consumer Price Index (CPI) show that inflation surged by 5.5% in the 12 months to January, up from 5.4% in December, with inflation expected to surge to 7% and potentially beyond in April once the energy price cap is removed. In the meantime, labour metrics and retail sales were positive. The UK unemployment rate held at 4.1% in the three months to December, in line with expectations. There was a further 108,000 increases in employment for January, a fresh record high, while headline average earnings increased from 4.2% to 4.3% (albeit below the inflation rate). Retail sales in January rebounded from the contractionary number in December.

Looking to the week ahead, the focus will be on the House of Common’s Treasury Select Committee. On Wednesday, Bank of England (BoE) Governor Bailey and three Monetary Policy Committee (MPC) colleagues will testify to the Treasury Select Committee for their quarterly update. Hot on the agenda is likely to be the back-to-back interest rate hikes but more importantly what they are expecting from monetary policy moving forward. The market will look for clues as to whether we will see further rate hikes in both March and May. Before the Treasury Select Committee, the market will be able to assess economic activity in the services and manufacturing sectors. The market will focus to see if there is a further expansion in the sector and the pace supporting it. In the meantime, PM Johnson is expected to announce the ending of all restrictions for England including the legal requirement to self-isolate in the case of a positive test later this month.

Minutes Indicate Abnormal Path for Rates Ahead of Preferred Inflation Metric

Price action surrounding the US Dollar was largely dictated by the risk-on/risk-off mood based on ongoing Ukraine/Russian tensions. The Federal Open Market Committee (FOMC) meeting minutes were also released and deciphered for clues on future policy action. The main takeaway from the FOMC January minutes reports was policymakers acknowledging that the imminent rate tightening cycle will differ from the previous cycle, with tightening set to be quicker in response to record inflation rates. The overall nature of the report was considered slightly less hawkish as policymakers did not discuss whether a 25-basis point or 50-basis point hike will be needed at the March meeting, only confirming that tightening is required. Meanwhile, U.S. retail sales increased by the most in 10 months in January, lifting the level of sales to a record high which is supportive of a rate hiking cycle.

Looking to the week ahead, the direction of the US Dollar is likely to be largely driven by the sentiment surrounding risk on/off with regards to escalating tension between Ukraine and Russia and the formal response from the West if an invasion does occur. Outside of the geopolitical tensions, the market will once again monitor for clues on the pace of the hiking cycle. On Tuesday, the market will monitor levels of economic activity within the PMI services and manufacturing data. The headline growth figures are set for release in the second reading of the GDP with a revision higher expected. Finally, the Federal Reserve’s (Fed) preferred reading on inflation is due to hit the wires. The consumer expenditure deflator is forecast to show another rise in annual headline inflation in January to over 6%, its highest for almost 40 years.

Single Currency Remains Under Pressure as Tension Mounts on the Doorstep

Euro was under pressure last week due to its proximity to the escalating tensions and its reliance on Russian energy. European Commission President Ursula von der Leyen insisted that Europe can cope if Russia decides to weaponise gas supplies over the Ukrainian crisis commenting that several countries were ready to step in should Russia limit gas exports to the Bloc. Currently, Europe imports approximately 40% of its gas supplies from Russia.

In the meantime, economic data showed the German ZEW investor sentiment index rose from the previous month, although marginally below the consensus forecast. The Eurozone GDP increased by 0.3% for the fourth quarter of 2021 compared to the previous three months with an annual increase of 4.6%, both figures reading in line with market forecasts. Additionally, Flash Unemployment in the Eurozone recovered to its pre-pandemic level, increasing 2.1% year on year to hit 161.8m for the fourth quarter of 2021. European Central Bank’s (ECB) Chief Economist Philip Lane had previously dismissed the notion of a new era for inflation until recently, but he has been revising his view, setting the stage for a policy shift at the ECB after nearly a decade of ultra-low interest rates and massive bond purchases. The ECB is under market pressure to raise rates on bank deposits, currently at -0.5%, in the face of stubbornly high eurozone inflation.

The single currency is likely to be tied to the risk sentiment tied to current geopolitical tensions. In terms of economic data, the PMI services and manufacturing is set for release today. On Tuesday the German IFO survey will be watched for clue on sentiment moving forward for the blue-collar sector. This will be of particular interest given the inflation backdrop, supply chain issues and now the geopolitical tensions.

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