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Sterling Data Points to Rate Hike but it Remains Fragile

The Sterling received a boost last week based on the markets’ expectations for a December rate hike supported by data, and comments by a Bank of England (BoE) official, as well as GBP Sterling / EUR Euro hitting fresh 20-month highs. Bank of England Governor Bailey stated that he is very uneasy about the inflation situation and all meetings are live for any potential rate hike. He went on to comment about the November decision, stating that it was a close call and that the real puzzle is on what will happen in the labour market. In the meantime, Chief Economist Pill highlighted that there are risks in leaving tightening too late, but also caveated this by stipulating the risks of going too early. Finally, Monetary Policy Committee (MPC) member Saunders reiterated his call for an immediate rate hike. In short, the tone of the Treasury Select Committee was hawkish and highlighted the strong probability of a hike next month.

In terms of economic data, there were several positive releases. UK labour data was released and showed a rise of 247k in employment in the three months to September, while the unemployment rate fell to 4.3% from 4.5%. The headline inflation data showed a sharp increase in the headline figure to 4.2% from 3.1% previously and above consensus forecasts of 3.9%. This is the strongest reading since 2012. Finally, retail sales rose for the first time in six months during October, according to official figures, suggesting shoppers started their hunt for Christmas gifts early as pressure intensifies on household budgets and concerns surrounding supply continues.

The Sterling is still generally on the backfoot despite comments and positive data as the market continues to contemplate the potential impact of stagflation, supply-side issues, and ongoing Brexit concerns.

Looking to the week ahead, the market will focus on the flash Purchasing Manager’s Index (PMI) services and manufacturing data for a gauge on economic activity on Tuesday. In addition, several BoE speakers this week will be closely watched for any clarification on their positions regarding the interest rate outlook. They include Governor Bailey and Chief Economist Pill, as well as the two most dovish MPC members, Haskel and Tenreyro.

Backdrop for Raising Rates in 2022 Strengthens amidst a Shortened Thanksgiving Week

The US Dollar remains at the front foot as economic data continues to paint an optimistic picture. Retail sales rose 1.7% month-on-month (MoM) in October, the highest level since March. The figure showed that consumer spending is rising quicker than market expectations which again raises the question of the Federal Reserve (Fed) speeding up the pace of tapering. This position was further reinforced by Fed speaker James Bullard commenting that the Fed should signal a more hawkish approach in the next rate meetings in preparation for higher inflation rates persisting for a longer period than anticipated. Fed member Charles Evans reiterated the Fed could start hiking rates in 2022.

Looking to the week ahead, it will be a shortened week for the US with Thanksgiving holiday on Thursday. As a result, economic data this week is front-loaded with flash PMIs which will be released tomorrow. These are also expected to remain in strong expansion territory. These figures are expected to provide a stronger backdrop for consumer spending and the durable goods numbers on Wednesday. In addition, the Fed’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) deflator is also set for release on Wednesday is likely to track the Consumer Price Index (CPI) data higher, with the annual rate for the headline index forecast to rise above 5% for the first time since 1990.

Finally, the minutes of the Fed’s November policy meeting will be watched for signs of a slightly more hawkish tilt.

Single Currency Lags like Monetary Policy as COVID-19 Restriction Adds a New Layer of Uncertainty

The single currency remains on the backfoot amidst diverging monetary policy with the UK and US whilst the evolving COVID-19 picture is adding another layer of complication. Last week, European Central Bank (ECB) President Lagarde reiterated that the conditions for raising interest rates were unlikely to be met in 2022. She added that tightening monetary policy now to temper high inflation would hurt the recovery and take effect just at the point when inflation was coming down. Lagarde highlighted that such a move would do more harm than good. She added that it was better to nurture the recovery through favourable financing conditions. ECB Council member Schnabel stated that by continuing to buy bonds, the ECB could signal that a rate hike is not imminent, confirming market expectations.

The single currency remains weak due to diverging interest rate policy. However, ECB council member Holzmann stated that quantitative easing has to stop given that high inflation is likely to persist. Despite these expectations, it seems that the ECB overall would maintain a dovish policy stance which would limit underlying Euro support with markets not pricing in an interest rate increase in 2022.

With COVID-19 case numbers rising significantly in a few countries, including Germany, the Netherlands, and Austria, the near-term outlook has weakened. Austria has implemented a national lockdown with speculation that Germany may follow suit. Last week, Austria became the first European country to make COVID-19 vaccination a legal requirement, with the law due to take effect in February. Politicians in neighbouring Germany are debating similar measures as intensive care units fill up, and case numbers hit fresh records. Several European countries saw angry protests about tougher restrictions turn violent over the weekend.

The week ahead will see the release of the flash PMI surveys for the manufacturing and service sectors on Tuesday and the German IFO survey – an index based on surveyed manufacturers, builders, wholesalers, services, and retailers – on Wednesday. ECB President Lagarde has two speaking engagements on Thursday and Friday where her tone and rhetoric will be closely monitored. In the meantime, the ongoing COVID-19 developments are likely to be the focus of the media.

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