10/02/11
Some Fed officials are getting more concerned about inflation. Richmond Fed President Lacker and Dallas Fed Chief Fisher have both expressed some reluctance about QE2 over recent days, suggesting that there is a growing risk of accelerating inflation. Fisher, who is a voter on the FOMC this year, has described QE2 as "pushing the envelope", while Lacker claimed that inflation is capable of accelerating "even if the level of economic activity has not yet returned to pre-recession trend". In our view, Lacker makes a strong point. There is a very real danger in advanced economies that central bankers rely too heavily on simplified models of excess capacity as intellectual ammunition for policy inaction.
Euro still looks well-bid. On a day when fx markets were generally becalmed, it was the continuing buying interest in the euro that again caught the eye. Having tested the 1.35 level earlier this week, it appears that shorts have scrambled for cover as hedge funds and sovereign wealth funds emerged from the shadows. The recovery in the euro has been gentle, and on relatively light volume, but still visible nonetheless. Helping the euro to climb above the 1.37 level has been a marginal improvement in interest rate differentials. EUR/GBP has drifted up above 0.85, and EUR/CHF reached 1.3170.
Pound unaffected by disappointing trade figures. Last month the excuse was higher oil imports and this month it was a surge in aircraft imports. Whichever way you cut and slice the latest UK trade figures, they are an unmitigated disappointment. In short, there is still absolutely no sign that the (supposedly) competitive exchange rate is triggering a decisive switch away from imports towards domestically produced goods, although there has certainly been some encouraging growth in exports. Indeed, December's goods trade gap of £9.25bn was a record monthly shortfall. In 2010, the goods trade deficit rose to £97.2bn, up from £82.4bn in the previous year. Imports of oil and basic materials alone rose by over 30% last year. The Bank would be aware that these figures imply that net exports actually subtracted from growth very slightly in the last quarter. Hopes that the trade side would contribute to growth at some point are looking increasingly forlorn.
Thursday: EC: ECB Monthly Report; IT: Industrial Production, December (expect 0.3%, previous 1.1%); UK: Industrial Production, December (expect 0.5%, previous 0.4%); MPC Meeting (no change); US: Initial Claims (previous 410K); Monthly Budget Statement, January (expect -$59bn).
Friday: GER: CPI, January f (expect -0.5% MoM and 2.0% YoY, preliminary estimate was 1.9% YoY); FR: Non-farm payrolls, Q4 (previous 0.1%); UK: PPI Output Prices, January (expect 0.5% MoM and 4.4% YoY, previous 0.5% and 4.2%); PPI Input Prices, January (expect 1.4% MoM and 12.7% YoY, previous 3.4% and 12.5%); US: Trade Balance, December (expect -$40.5bn, previous -$38.3bn); University of Michigan Consumer Confidence, February p (expect 74.5, previous 74.2).
Will the indecisive MPC finally bite the bullet and raise rates today? Statistically, the chances are certainly higher this month. During the MPC’s history, exactly half of all rate changes have occurred in inflation report months, the next one due to be published on Wednesday. Inflation report months are an opportunity for the Bank to re-assess the longer-term inflation outlook, so it is not surprising that it can result in changes of views within the committee. In recent weeks, both the currency and interest rate markets have priced-in a higher probability of a rate hike over coming months, in response to both the much higher-than-expected December inflation outcome and the fact that two MPC members voted for a rate increase at the January meeting. Looking at the forward market in overnight rates, in early January a 20% probability was attached to a 25bp rate hike at the May meeting. By yesterday, this had adjusted to being fully factored in. The pound's sensitivity to interest rate expectations has certainly increased so far this year, with the correlation between cable and two-year interest rate spreads (between the US and the UK) having increased to around 0.55 from 0.40.
Although surveys of economists are not showing any officially going for a rate hike, the market has definitely priced in some risk of a move. As such, given this heightened sensitivity to interest rate spreads, the pound may suffer in the near term if there is a no-change decision today. Thereafter, it is the inflation report next week that will serve to solidify or undermine market expectations for a tightening in May. Sterling will need a relatively hawkish report to keep its place as one of the better-performing currencies of the year so far.
Although surveys of economists are not showing any officially going for a rate hike, the market has definitely priced in some risk of a move. As such, given this heightened sensitivity to interest rate spreads, the pound may suffer in the near term if there is a no-change decision today. Thereafter, it is the inflation report next week that will serve to solidify or undermine market expectations for a tightening in May. Sterling will need a relatively hawkish report to keep its place as one of the better-performing currencies of the year so far.
Commentary
Julius and Besley argue for a rate hike. Ex-MPC members De-Anne Julius and Tim Besley both suggested yesterday that they would vote for a rate hike today if they were still on the Committee. They opined that a 25bp rate rise would send a useful signal to both markets and consumers that the Bank was concerned about rising inflation. Julius was particularly scathing of Mervyn King's recent attempts to separate the external inflation pressures from the domestically-generated, suggesting that such an exercise was 'fanciful'.Some Fed officials are getting more concerned about inflation. Richmond Fed President Lacker and Dallas Fed Chief Fisher have both expressed some reluctance about QE2 over recent days, suggesting that there is a growing risk of accelerating inflation. Fisher, who is a voter on the FOMC this year, has described QE2 as "pushing the envelope", while Lacker claimed that inflation is capable of accelerating "even if the level of economic activity has not yet returned to pre-recession trend". In our view, Lacker makes a strong point. There is a very real danger in advanced economies that central bankers rely too heavily on simplified models of excess capacity as intellectual ammunition for policy inaction.
Euro still looks well-bid. On a day when fx markets were generally becalmed, it was the continuing buying interest in the euro that again caught the eye. Having tested the 1.35 level earlier this week, it appears that shorts have scrambled for cover as hedge funds and sovereign wealth funds emerged from the shadows. The recovery in the euro has been gentle, and on relatively light volume, but still visible nonetheless. Helping the euro to climb above the 1.37 level has been a marginal improvement in interest rate differentials. EUR/GBP has drifted up above 0.85, and EUR/CHF reached 1.3170.
Pound unaffected by disappointing trade figures. Last month the excuse was higher oil imports and this month it was a surge in aircraft imports. Whichever way you cut and slice the latest UK trade figures, they are an unmitigated disappointment. In short, there is still absolutely no sign that the (supposedly) competitive exchange rate is triggering a decisive switch away from imports towards domestically produced goods, although there has certainly been some encouraging growth in exports. Indeed, December's goods trade gap of £9.25bn was a record monthly shortfall. In 2010, the goods trade deficit rose to £97.2bn, up from £82.4bn in the previous year. Imports of oil and basic materials alone rose by over 30% last year. The Bank would be aware that these figures imply that net exports actually subtracted from growth very slightly in the last quarter. Hopes that the trade side would contribute to growth at some point are looking increasingly forlorn.
Looking Ahead
Thursday: EC: ECB Monthly Report; IT: Industrial Production, December (expect 0.3%, previous 1.1%); UK: Industrial Production, December (expect 0.5%, previous 0.4%); MPC Meeting (no change); US: Initial Claims (previous 410K); Monthly Budget Statement, January (expect -$59bn).
Friday: GER: CPI, January f (expect -0.5% MoM and 2.0% YoY, preliminary estimate was 1.9% YoY); FR: Non-farm payrolls, Q4 (previous 0.1%); UK: PPI Output Prices, January (expect 0.5% MoM and 4.4% YoY, previous 0.5% and 4.2%); PPI Input Prices, January (expect 1.4% MoM and 12.7% YoY, previous 3.4% and 12.5%); US: Trade Balance, December (expect -$40.5bn, previous -$38.3bn); University of Michigan Consumer Confidence, February p (expect 74.5, previous 74.2).
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