GBP Steadies Ahead of BoE but Watch Out!

Daily FX Market Roundup 05.11.16

In the next 24 hours, FX traders will turn their focus to the British pound because Thursday’s Bank of England monetary policy meeting and Quarterly Inflation Report are two of the most important event risks this week. With the U.K. referendum right around the corner, the BoE has a lot to consider this month and there are 3 specific issues that investors will be focusing on – growth, inflation and Brexit. In recent weeks, some major central banks have eased monetary policy while a slowdown in the U.S. economy caused the Fed to retreat from its hawkish stance. Recent U.K. economic reports show similar weakness in the U.K. economy and according to the table below, we’ve seen nothing but deterioration in U.K. data since the April meeting. With manufacturing and service sector activity slowing, wage growth has been pressured causing consumers to cut back and confidence to fall. Based on these measures alone, the BoE’s February growth forecasts look too optimistic.

Inflation however is on the rise with oil prices up more than 45% since the February inflation report and sterling trading lower. The latest consumer and producer price reports won’t be released until after the central bank meeting but rising inflation expectations along with price pressures will prevent the central bank from talking about easing. If the central bank lowers its growth forecasts and leaves the inflation forecasts unchanged, sterling will fall but if they revise down one and up the other the net impact should be positive for sterling because the upgraded inflation forecasts leaves the BoE slightly more hawkish than most of its peers.

Yet the main focus tomorrow may be what BoE Carney says / doesn’t say about Brexit. We know that Carney feels that Brexit poses the biggest domestic risk to financial stability but he’ll have to choose his words carefully to avoid being criticized for interfering with political matters. He’ll have to sound neutral about his preference for Leave vs. Stay while at the same time being realistic about how Brexit could impact the economy. There’s also been some discussion within the BoE about presenting separate Remain and Stay forecasts but we think that’s unlikely. Chances are they will keep their outlook focused on the short term. However sterling could fall if Carney suggests that they stand ready to ease policy if Brexit causes significant disruptions to the economy. As you can see, there’s a lot of confusion going into tomorrow’s event risk so while sterling is holding steady ahead of Super Thursday, the currency is likely to see big moves in the hours that follow.

Meanwhile the U.S. dollar traded lower against all of the major currencies as the greenback begins to lose its mojo after a few days of solid gains. No significant U.S. economic reports were released today and tomorrow’s jobless claims report is not expected to have a significant impact on the currency. U.S. dollar traders will have to wait until Friday for some action when we have U.S. retail sales, producer prices and the University of Michigan Consumer Sentiment index scheduled for release. FOMC voters Mester, Rosengren and George are also scheduled to speak at the end of the week, making Friday a particularly active day for the greenback.

EUR/USD finally rebounded after 6 straight days of losses. Today’s recovery keeps the uptrend in the currency pair intact but there’s significant resistance above current levels at 1.1465 (early April consolidation high), 1.1500 and 1.1.1615 (May high). This week’s Eurozone economic reports have been disappointing and tomorrow’s Eurozone industrial production release isn’t expected to lend much support to the single currency because Germany and France reported significant declines in IP. However the question of whether EUR/USD breaks 1.1500 or drops below 1.1300 will be determined by Friday’s economic reports. Aside from the U.S. data mentioned, first quarter GDP numbers are also due for release from Europe and growth is expected to have accelerated in the first quarter.

The drop in oil inventories and rise in oil prices drove USD/CAD lower for the second day in row. Although today’s move in oil has taken prices to the top of its recent range, the issues of supply and demand remain. Therefore we continue to look for oil to peak near current levels, leading to a renewed decline in the Canadian dollar. With that in mind, we prefer to buy USD/CAD between 1.2 and 1.2825.

Stronger consumer confidence and a smaller decline in home loans failed to lend support to the Australian dollar, which ended the North American trading session unchanged. The New Zealand dollar on the other hand extended its gains after the Reserve Bank of New Zealand expressed urgent concerns about house prices in Auckland. Governor Wheeler said they were seriously looking at more macroprudential measures, which may include tighter loan to value ratios or stricter debt to income requirements to curb price growth. Although the central bank also expressed concern about lower dairy prices, the greater issue of high house prices reduces the chance of near term easing by the Reserve Bank – hence the rise in NZD.

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