Dollar on ‘Front Foot’ as Federal Reserve are Due to Announce Monetary Policy Decision
Sterling exchange rates have had a slow start to this week’s trading in the lead up to this month’s Federal Reserve and Bank of England interest rate decisions. GBP/EUR is trading around the 1.164 level with GBP/USD rates sitting above 1.365 on the interbank. Inflation data released last week showed that inflation in the UK has risen to 3.2%, from a reading of 2% in July, which is the highest rise in inflation month on month since records began in 1997 when the Bank of England was handed independence to manage inflation. Typically, when inflation levels are deemed too high in a country, the central bank in question will raise interest rates to help deal with the inflationary risk. If the BoE were to raise interest rates, then this would help the pound and other UK investments become more attractive to overseas investors, which in turn could drive sterling exchange rates higher.
Yesterday, a monthly survey conducted by Citi/YouGov revealed that the British public expects inflation to rise above 4% in the next 12 months. This highlights that the British consumer is becoming increasingly unsettled by the rise in inflation. These concerns could influence the Bank to reconsider its plans to raise interest rates sooner than planned, with commentators expecting a hike in 2022.
When the Bank of England meets tomorrow for their latest monetary policy meeting, they are forecast to leave interest rates unchanged at 0.1%, however, any deviation from this has the potential to cause volatility on the market. Swedish bank SEB, expect the bank to call for raising interest rates in the first quarter of 2022. This would put the Bank ahead of the Federal Reserve and the ECB in terms of hiking rates and could provide support for sterling.
The furlough scheme is due to end next week with many UK workers still being supported by the scheme. The current unemployment rate in the UK is 4.7%, which is the lowest it has been in 2021. A sharp rise in unemployment following the end of the furlough scheme could put pressure on the UK economy and negatively affect sterling rates. However, last month the ONS reported an estimated 935,000 job vacancies. The UK government will hope that many left unemployed by the furlough scheme will find opportunities in new sectors.
In Europe, euro sellers have benefited from a lull in sterling support with EUR/GBP testing the 0.86 level for the first time in over 3 weeks. Thursdays Bank of England interest rate decision could also spell positive news for the euro. Analysts at Capital Economics said that while UK inflation is burning hot it will fall rapidly in 2022, easing pressure on the Bank to raise interest rates. Many believe the pound has begun to price in a potential interest rate hike so any delay in the timing of a rate rise could unwind recent sterling gains.
On Sunday citizens in Germany will be heading to the polls for the federal elections which will see Chancellor Angela Merkel step down after 16 years in power. Current finance minister and vice-chancellor Olaf Scholz from the centre-left party SPD (Social Democrat Party) is expected to be named the victor. SPD’s manifesto encompasses left-leaning taxation and social policies, and a pro-EU stance. The new German government is expected to be a coalition of parties with some experts expecting the coalition discussions to ‘drag on’. The Greens, Die Linke, and FDP (Free Democratic Party) have all been mentioned as potential coalition partners. If an agreement takes time to be reached, then this could spell trouble for the euro as the political landscape has the potential to influence rates.
Tomorrow morning, we will see the latest release of composite and manufacturing PMI data from the eurozone, they are forecast to read 58.5 and 60.3 respectively.
The dollar has started the week on the front foot against several currencies following a shift in global risk sentiment. The risk-off move has seen the dollar benefit from safe-haven inflows. The US is viewed as the ‘safe-haven’ for many as the largest economy in the world. Due to this, investors choose to hold US investments and government bonds during times of economic uncertainty. The catalyst for the shift in sentiment has been influenced by the current crisis in the Chinese property sector. Evergrande, one of the country’s largest developers is on the cusp of collapse. They have more than $300 billion in debt, meaning Evergrande’s liquidity crisis could spell long-term trouble for global markets.
This evening the Federal Reserve will meet in the US to reveal their latest monetary policy decision. Last month’s data revealed that inflation levels in the US remained above 5% for the fourth month in a row. There is growing concern amongst Americans that a lack of willingness to act could have negative long-lasting effects. “The Fed risks cementing an inflation rate above 2% that would be costly to reverse while providing no benefit to job creation,” said John Ryding, chief economic advisor at Brean Capital. “The Fed is falling further behind and could be making a major policy error at this point in time.” He added.
A CNBC survey of 32 market participants shows that they expect the Federal Reserve to announce a reduction in its $120 billion monthly asset purchase program in November and begin to taper in December. Interest rates are currently at 0.25% and are forecast to remain the same following today’s meeting. The Federal Reserve has signalled a plan to raise rates in 2023, however, some market analysts expect this date to be brought forward. The dollar could find significant support and cement some of the gains made this week if there is an indication of plans to raise rates sooner.
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