The recent rally in the dollar came to a stop yesterday, with GBP/USD pushing into the upper half of the $1.38-1.39 band and EUR/USD climbing towards the $1.175 mark. The action was prompted by the release of US CPI data for July, which came in marginally below forecast. The softness was concentrated in the core CPI (ex-food & energy) index, which rose by 0.3% m-o-m (4.3% y-o-y) relative to a consensus projection for a 0.4% increase (4.3%). In contrast, the headline index printed in line with expectations, with the y-o-y rate holding at 5.4% after a 0.5% m-o-m increase.
The market reaction to what was a minor downside miss reflected the fact that traders had been primed for an upside surprise, which we had flagged yesterday. In our view, however, the report didn’t offer decisive evidence in support of either Team Transitory’s or the inflation hawks’ arguments. Team Transitory’s claims were aided by data showing that we are beginning to see some moderation of price pressures in sectors that were most exposed to re-opening effects/supply chain issues. However, this was inevitable as it was not realistic to assume that used car prices were going to keep rising by circa 10% m-o-m for instance. Boosting the inflation hawks claims, though, was the fact that we began to see a broadening out of inflationary pressures into sectors such as hospitality, healthcare and housing.
Our view is that inflation will ease in the coming months as re-opening effects fade, but will hold well above target as supply-side issues persist. This will give the Fed scope to delay tapering its asset purchase programme until Q421/Q122, before commencing hiking in Q422 as a robust labour market sees wage inflation remain elevated and prompts firms to raise prices. This in turn will see the dollar remain supported over a 12-month horizon. In the more immediate future, however, the greenback could struggle to reverse its recent losses, particularly if today’s producer price inflation figures for July surprise to the downside.
Sterling has remained well supported over the past 24 hours, with GBP/EUR trading in a tight band around the €1.18 level. This morning the release of UK GDP figures had a limited impact on the currency as they printed in line with expectations.
The data confirmed the economy expanded by 4.8% q-o-q in the quarter, leaving it 4.4% below its Q419 level. Unsurprisingly, growth was driven by consumer spending, which surged as the UK’s vaccination campaign saw the majority of Covid restrictions rolled back in April and May. Business investment also made a large positive contribution, though was held back by supply chain disruptions. The persistence of these disruptions and the drag from the ‘pingdemic’ likely saw growth lose momentum in July, but we see scope for a pick-up in August as the positive impact from Freedom Day and the loosening of self-isolation requirements feed through. However, a recent uptick in UK Covid cases does pose some downside to the outlook.
Over in the eurozone, a quiet session lies ahead, with a quiet macro schedule set to offer little direction to the single market currency. The only release of any note today is the June print of eurozone industrial production, with output projected to have dipped by 0.2% m-o-m as the German auto sector remains weighed down by semiconductor shortages.
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