Misaligned Data Focus For FX
The market continued to gain optimism in the US over the past week, which was only matched by its pessimism on the other side of the pond. We still see a fundamental structural case for this as Trump prioritises the US private sector while the UK crowds it out with tax hikes to fund an expansion of the state and borrowing. However, uncertainty about the extent and timing of the divergence leaves macro data to drive monetary policy decisions in December.
We believe the prevailing data no longer justify the extent of pricing divergence in December that underlies crowded bearish Euro positioning. The flash PMIs for November extended their US-Europe spread, but that arguably says more about sentiment around the US election result than activity growth. PMIs have also struggled to signal official activity and suffer residual seasonality, including weakness into year-end. Policymakers need to consider data more broadly.
In the UK, a surprising airfare rebound extended CPI inflation’s energised rise to 2.3%. Its higher weighting in core and services measures compounded the upside surprise there. Underlying inflation also strengthened on other measures, like the median, and looks inconsistent with a sustainable return to the inflation target. We still expect inflation to trend above the target in 2025 on excessive unit labour cost pressures. The BoE can remain gradual in its easing cycle, skipping a cut in December (see UK Inflation Flies Cuts To 2025).
October's final Euro area inflation print confirmed its surprisingly steep rise to 2% y-o-y. Strength was not only broad across countries but components with median rates rising. Underlying inflation pressures were broadly above expectations and target-consistent levels. Confirmed price and wage inflation strength adds to hawkish GDP and unemployment news, curbing the case for 50bp to remain less likely than the dovish market hopes (see EA Inflation Doesn’t Need A 50bp Cut).
Upwards revisions to Euro area labour costs and a jump in negotiated wage settlements extend cost growth inconsistent with a sustainable return to the 2% inflation target. The ECB hopes this will subside swiftly in 2025, with productivity growth and squeezed profit margins helping contain inflation. But these hopes seem set to be disappointed. Persistent wage pressures should prevent a 50bp rate cut in December and limit further cuts. Less dovish fundamentals would feed bullish Euro seasonality, magnified by crowded bearish positions (see EA Wages Are Too Inflationary For 50bp).
Central bank decisions haven’t added much to the debate this week, although Indonesia highlighted the spillover of rising US rates to its policy via exchange rate pressures while holding rates. Next week features Korea also probably on hold, but the RBNZ is expected to cut forcefully again.
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Inflation Forecasts
Euro area inflation is set to rise again in the November flash, but we expect the extent to be more limited than the market assumes, reaching 2.2% instead of 2.4%. Base effects are primarily to blame. Most notably, German package holidays experienced an unseasonably slight decline last November of 11.3%, less than half the usual cut. That effect promptly unwound in December with a smaller price rise for Christmas. The reassertion of more regular seasonality would weigh on headline inflation in Germany and the Euro area. It would also hit the core and services measures harder, with the core rate potentially rounding down while services inflation slows by 0.2pp.