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Conflict Weakens Single Currency To Multi-Year Lows As The Price Of Oil Highlights Inflationary Pressures Ahead

Last week, risk-off continued to dominate currency markets as we saw an escalation in both the sanctions against Russia and intensified shelling and attacks on Ukraine. Due to Europe’s proximity and its current dependence on Russian energy, we saw the single currency slide to its lowest against the Greenback since March 2020 and its lowest level against Sterling since Brexit.

In terms of economic news and data, Federal Reserve (Fed) Chair Powell dampened expectations of a super hike this month but left the potential for a 50-basis point hike on the table for a future meeting if inflation proves difficult to contain. The highly anticipated jobs figure was positive, Non-Farm Payrolls increased by 687,000 in February, while the unemployment rate fell from 4.0% in the month before to 3.8%.

Comments from the European Commission highlighted that the concern with inflation is now that we raise too late rather than too soon, which sets up the European Central Bank (ECB) policy meeting nicely for this week. However, pressure remains on the single currency due to the impact of the escalating war on its boarders.

Over the weekend, the Biden administration was considering whether to prohibit Russian oil imports into the U.S. without the participation of its allies in Europe, at least initially, according to people familiar with the matter. The net impact is that the price of oil has hit the highest level since 2008, increasing by circa 50% in the last two weeks. This could have lasting effects on an already high inflationary environment.

Will the UK Return to Growth?

Sterling will remain sensitive to risk trends surrounding the situation in Ukraine. The market will keep a close eye on the momentum the UK economy has given the backdrop for monetary policy especially with the Bank of England (BoE) meeting next week. Of note this week we have the British retail consortium sales numbers set for release on Tuesday whilst the monthly GDP contracted last month. It is expected that GDP will return to growth and have increased by 0.4%m/m after falling by 0.2%m/m in December, led by higher services output as Omicron case numbers fell and restrictions were eased back.

ECB Meeting to Deliver New Forecasts. What Will These Mean for Monetary Policy?

The Euro is under greater pressure due to its proximity to the conflict and reliance on Russian oil. Last month the ECB signposted that they would be updating their growth and inflation forecasts at this meeting (Thursday). The market will be interested to see if we have had a move away from the transitory inflation stance. Eurozone CPI inflation increased to 5.8% in February, and it would not be surprising to see it rise above 6%, and possibly close to 7%, in the coming months given the increase in energy prices. The ECB’s new economic projections accompanying next week’s policy update will show near-term inflation staying higher for longer. Will the ECB still be expecting these to fall back to or below the 2% target in 2023 and 2024? The market will decipher the rhetoric for clues on future policy action.

US Inflation to Continue Rising

There are no key speakers from the Fed this week which is protocol ahead of the interest rate decision next week. The US Dollar will remain as a risk barometer for currency movements with regards to the ongoing conflict in Russia. The key economic release this week will be the Consumer Price Index (CPI) on Thursday. The annual CPI is expected to show inflation increasing to 7.9%, up from 7.5%. It is now set to peak above 8%, a level that was last exceeded in 1982. This will maintain the pressure for interest rates to rise, but the impact of the unfolding events in Ukraine has instilled a degree of caution. Also set for release is the JOLTS job openings on Wednesday and the UoM Consumer sentiment on Friday.

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