FX outlook: Parky’s quick take

December 21 2020

Neil ParkerFX Markets Strategist

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What’s happening with currencies this week? Neil Parker, Market Strategist shares his views.

United Kingdom: The pound endured a topsy-turvy week

Last week the Bank of England met, and having loosened policy in November, there was little expectation of a further reduction in interest rates or expansion of its quantitative easing programme. The Bank of England indicated that they would tolerate an inflation spike in the event of a no-deal Brexit trade outcome, as the UK economy is in a worse place than it was during previous potential no-deal outcomes. The Bank suggested that the positive news about vaccines was likely to limit any additional downside to the UK economy in 2021, although the end of 2020 and early 2021 could be trickier, given the additional restrictions and lockdowns already announced. The indications are that, not only will monetary policy not be tightened for the foreseeable future, but also that the Bank would consider additional loosening if necessary, and under a no-deal on UK/EU trade.

Meanwhile, the Brexit negotiations stretched on, making some progress on the level playing field, but again hitting roadblocks on certain issues such as state aid and fishing. With time short, and the UK parliament officially in recess until 5th January, it is unclear whether a deal can be ratified ahead of the deadline, and reports at the end of last week showed tailbacks at the channel tunnel as businesses scrambled to stockpile ahead of the deadline. The pound endured a topsy-turvy week as the newsflow on a trade deal ebbed and flowed, at one point looking a lot more likely and then swiftly afterwards a lot less probable. Over the weekend, the UK government announced a ‘lockdown’ for most of London, the South East and parts of East Anglia, prompting a sharp slide in the pound’s value, as goods transit was halted from mainland Europe.

On the data front, the labour market reported a further drop in employment and rise in unemployment in October, though neither were as bad as expected, whilst the claimant count rose sharply in November, but that was in response to the lockdown that England had gone through throughout the month. Consumer prices inflation dropped to just 0.3% y/y in November, driven by lower clothing and footwear and food & alcohol prices, and retail sales volumes fell in November, but by less than expected. Moreover, the percentage of online retail sales as a share of the total retail volumes rose to an all-time high of 36%, again driven by the lockdown in England.

With November public finances and Q3 GDP data due for release this week, there is still some interest in the domestic economy to offer the financial markets reason to move, but realistically the attention will again be drawn to the UK/EU trade discussions to see if a breakthrough can be made ahead of Christmas. The pound remains at risk of dropping on the back of further deadlock, but could both parties agree to keep talking into the new year? Repeatedly the UK government has suggested it would walk away at the end of the year if no deal had been secured, but would they really do that given the progress reportedly made?

Europe: Europe locks down further

Last week saw more countries across Europe increase restrictions on businesses and individuals, as infection rates continued to increase in Germany and remained elevated in France and other major countries. The decision to lockdown a number of countries will have an additional negative effect on the economic activity, which was already set for a poor end to 2020. However, with the prospect of a lockdown continuing into 2021, and concerns over vaccine supplies, Europe could be in lockdown for longer than originally planned, and the fiscal implications for each country affected are likely to prove significant.

The movement of goods was temporarily interrupted over the course of the weekend, as the flow to and from the UK was halted amidst fears of the new COVID variants’ heightened virulence. Although it would seem that the flow of goods resumed on Monday morning, that will not have alleviated fears that there is likely to be months of additional restrictions around Europe. The European Central Bank’s extension to its keynote stimulus programmes may now be fully utilised, and warnings over deflation may heighten, with demand restricted for a longer period.

This week sees no important releases due. Will the concerns on both UK/EU trade continue to increase, or will the new developments in COVID look to alter the views of negotiating teams and the politicians behind them, such that a deadline delay, of a few weeks will be agreed? For the EUR, the upward momentum has been arrested, and that may prove welcome news to the ECB and other authorities, who will have been concerned about the downward pressures on inflation. 

United States: US Fed extend bond purchases as lawmakers agree stimulus  

The US Federal Reserve meeting last week was the major event of interest for the markets. There had been hints about a possible expansion of the bond buying programme, to buy more assets more quickly. In the end, the Fed left the bond purchases at $120bn per month, but indicated that they would continue to buy bonds until substantial progress on employment and inflation had been made. The Fed also upgraded their forecast for growth in 2021 to 5% from a previous 4.2%. The new dot plots, which are the Fed’s own survey of what its committee members expect in terms of monetary policy going forward, saw one more member of the FOMC predict that interest rates would rise in 2023 versus the September dot plots.

Lawmakers in the US agreed to roughly $900bn of fiscal relief, including checks to individuals of $600 and an extra $300 in claimant support per week for jobseekers until the end of March. The deal still needs to be signed off by the President, but the bi-partisan accord breaks months of deadlock between Democrats and Republicans.

In terms of the US data and survey releases there was some strength in the industrial production and additional strength from the housing market figures, which remain on an upward trend.

This week sees more activity data in the form of final Q3 GDP figures, November personal income and spending, and new home sales, also for November. There are also consumer confidence surveys from the Conference Board and University of Michigan, both for December. Overall though the data and surveys are unlikely to offer the USD much additional support, but the increasing sense of crisis in Europe could offer renewed strength to the USD as a safe-haven.

Central banks: Rates left on hold last week, Turkey to hike this week

Last week saw many meetings across the globe, but there were no actions from any of those with room to manoeuvre on conventional policy, and there was no unconventional loosening either. Realistically, of all the central bank meetings from likes of Kazakhstan, Hungary, Indonesia, the Philippines, Switzerland, Norway, the Czech Republic, Mexico, Japan and Russia, there was only perhaps one or two that might have loosened but chose not to.

This week, jokes aside on Turkey voting for Christmas, the central bank are likely to hike interest rates again and this time by a further 2 percentage points after the 4.75 percentage point hike back in November. That would put the headline interest rate at 17%, still a long way short of the 24% peak in 2019, but by then monetary policy may no longer be undermining the lira. Whatever the decision from the central bank of Turkey, it will be the response of the lira that is likely to determine whether more monetary tightening is required in the months ahead. Also this week, the central bank of Thailand meets, although no monetary loosening is expected. Additionally, there are signs that economic conditions are improving across the region, so it is highly unlikely that we will see any Asian central bank further loosen policy over the next few meetings. 

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