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Jamie Jemmeson
November 29, 2021

Could The New COVID-19 Variant Change UK Rate Expectations?

Could The New COVID-19 Variant Change UK Rate Expectations?

Sterling remained vulnerable last week as risk trends surrounding COVID-19 reared its ugly head once again. Already under pressure from the measure being undertaken in Europe the Omicron variant has added a further layer of uncertainty. There was an announcement late on Thursday of travel restrictions into England from six southern African countries in response to a new COVID-19 variant. The new variant has also added to the uncertainty of December’s interest rate meeting. Yields have declined in most government bond markets including the US and the UK. This could reflect a move into safe-haven assets in a more ‘risk-off’ environment and/or speculation that near-term monetary policy tightening is now less likely whilst central banks take a ‘wait and see’ approach. Brexit stresses continued in the French fishing sector with France acting by blocking the channel tunnel.

In the meantime, Bank of England (BoE) MPC member Haskel stated that a gradual increase in interest rates would represent a return to normal. However, he still expressed reservations over an early move to hike rates. Haskel went on to comment that labour-market developments would be very important and that the bank needs to be vigilant about rising labour costs. BoE Governor Bailey also commented that the labour market is very tight, and he also warned that the bank may not give significant forward guidance in the future.

Data was positive as the UK CBI industrial trends index strengthened to 26 for November, up from 9 the previous month, comfortably above consensus forecasts of 18 and the strongest reading since 1977.

Looking to the week ahead it is fairly quiet in terms of economic data with headlines likely to focus on global restrictions following the concerns surrounding the Omicron coronavirus strain. With key mid-December monetary policy updates for the UK fast approaching, market attention will stay focused on any comments from central bankers. BoE Governor Bailey is scheduled to speak but about insurance regulation and so he may not say anything about monetary policy on Wednesday.

The Dollar Remains Well Supported On Risk Sentiment And A Hawkish Federal Reserve

The US Dollar remained well supported against most major currencies last week as the Federal Reserve (Fed) continued to signal a hawkish tone towards accelerating the pace of tapering their asset purchase program. The Dollar index traded above 97.00 while reaching highs against the Euro not seen since June 2020. The latest Fed policy meeting minutes released on Wednesday showed that a growing number of policymakers have sided towards accelerating the pace of asset purchases and raising US interest rates sooner in 2022, should inflation become more persistent. Personal Consumption Expenditures (PCE) data confirmed that US inflation has continued to rise heading into Q4 of this year. The figure rose to 4.1% on a yearly basis. Elsewhere, weekly unemployment claims fell to the lowest level since 1969 with Q3 GDP data revised upwards to 2.1%. Last week President Joe Biden announced he would nominate the current Fed Chair Jay Powell for a second term. Lael Brainard was considered as the alternative for the main role and was selected as Vice Chair, replacing Richard Clarida. The announcement to re-elect Powell saw US equities fall and 10-year US treasury yields increase above 1.6%.

Looking ahead to this week, markets focus will turn to the release of November’s non-farm payrolls data on Friday. Ahead of the key jobs data on Friday, investors will give attention to Fed Chair Powell’s commentary on Monday followed by his testimony on Tuesday. Other highlights on the weekly calendar is the OPEC meeting on Thursday. The Feds’ Beige Book report is scheduled for release on Tuesday. The ADP jobs report will be released on Wednesday with the updated ISM Non-Manufacturing report is set for release on Friday, however, the data is likely to be overshadowed by the key jobs data, as the Fed has cited the labor market as one of the key conditions in determining the pace of monetary policy tightening as we head into 2022.

COVID-19 Restrictions Add To EU Single Currency Woes

The Euro was weighed down by concerns surrounding COVID-19 developments with unease surrounding the latest imposition of restrictions and fears that further measures would need to be introduced over the next few weeks. Compounding these concerns is news surrounding the new Omicron variant. In this environment, there were further concerns that the economic recovery would be compromised. Lockdowns are already taking place and the introduction of compulsory vaccination is being passed and discussed by regions.

There was some positive news as economic activity surprised the upside with the release of the purchasing manufacturing and service sector data. The French PMI business confidence data was stronger than expected for November and German data also beat expectations with the composite output index strengthening. The Eurozone PMI manufacturing index edged higher and posted above expectations. The services sector also confounded expectations with a net gain to a 3-month high. However, the German IFO business confidence index declined and was marginally below consensus forecasts. There was a limited decline in the current conditions index with a similar drop in the expectations index. The IFO commented that supply chain bottlenecks are placing companies under a lot of stress. There is scope this figure will drop further as COVID-19 restrictions start to come into effect as conditions continue to worsen.

Looking to the week ahead, the November CPI inflation is expected to have risen further above the European Central Bank’s (ECB) inflation target. However, that will probably have little impact on market interest rate expectations as policymakers continue to signal that they see the increase as temporary and so are unlikely to tighten monetary policy in response. The recent rise in Eurozone COVID-19 cases and the resulting threat of more restrictions, including a possible lockdown in Germany, will probably reinforce expectations of ECB policy. On Thursday the unemployment data is due whilst on Friday the all-important retail sales are set for release. In the meantime, the market will also keep a vigilant ear on ECB President Lagarde’s rhetoric on Friday as she is due to speak at a news conference titled “Financing The Covid Recovery With New Economic Headwinds” at the Reuters Next online conference.

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