Currency Update – 7 August 2023

GBP
The Bank of England yesterday hiked UK interest rates by a further 25bps to 5.25%, pushing borrowing costs to their highest level for 15years. Leading into the meeting, analysts had been undecided on the outcome, with many opting for a bolder 50bps move, given that UK inflation remains stubbornly high, even if recent data has teased, finally showing some worthy signs of moderating. With there being a surprising three-way split within the BoE’s voting committee, it is abundantly clear that divisions are now emerging among MPC members. That could play a key role in future BoE decisions, especially if the doves grow in numbers. We’d love to be a fly on that particular wall.
Unlike in the US, the UK economy has remained particularly fragile, with tepid growth and a cautious outlook persisting. High borrowing costs have been a drag on economic growth, especially given just how sensitive the property market remains to interest rate changes. The fact that the BoE have now raised UK rates for 14 meetings in a row will hardly help to boost sentiment there.
In their accompanying statement, the BoE warned that borrowing costs are likely to remain elevated, suggesting that the UK is likely to avoid a recession, although Andrew Bailey is unlikely to put his own house on that outcome. The latest GDP report will tell us more on that this time next week. Furthermore, Bailey implied that the BoE may now be reaching their terminal (or final) rate, saying on more than one occasion that there was ‘more than one path’ that could help to bring inflation back to its target.
Looking ahead, many analysts are now openly calling for no further rate hikes from the BoE in this cycle, although we will need to see inflation to continue to fall at the recent pace for that group to grow in numbers.
As for the pound, well if we were using a football analogy, we might have called it a classic game of two halves. Leading into the BoE, GBP/USD continued to descend alongside most major currencies against the surging dollar this week (see USD), briefly slipping to below 1.2650, however, the pound has rebounded in the immediate aftermath of the BoE meeting, with GBP/USD rising modestly to back over 1.2700. Similarly, GBP/EUR had earlier slipped to as low as 1.1550 but rebounded back over 1.1600 by the close. Sell the rumour buy the fact, as they say Kammy?
EUR
There was some slightly better than expected news out of Europe (for once) this week, with most of the individual manufacturing PMIs beating estimates, led by worthy gains in France and Italy, while Germany matched expectations. Only Spain let the side down. European unemployment also fell more than had been expected in Germany and the region as a whole.
That good news continued, with confirmation that the region’s economy had expanded more than expected during the latest quarter. Growth increased by a respectable 0.3% on a provisional basis during Q2, having been expected to have risen by 0.2% over the period, following a 0.1% decline in Q1. A separate report confirmed that consumer prices increased 5.3% on an annual basis during July, which was as expected. However, core inflation, which strips out volatile groups such as food and energy, remained at 5.5% throughout the region. That is the first time that core CPI has risen above headline CPI for two years and highlights the sticky nature of core prices.
With German Retail Sales also showing a lesser decline that the previous month, the single currency initially started the week off on a stronger footing, with EUR/USD rising to 1.1046, having fallen below 1.1000 toward the end of last week. However, the pair struggled to maintain the gains above 1.1000, and succumbed to the broadly strengthening dollar. Despite this, there were signs that the recent rout may be finding some support, with the pair bouncing from a low of just over 1.0900 by yesterday (Thursday) afternoon. A batch of inflation reports throughout the region, including Germany and Spain, will be released next week. Further signs of moderation will add to the growing perception that the ECB are set to halt further rate hikes.