Sovereign International Daily Market Report
ECB lays the groundwork for a June interest rate cut
Highlights:
Currencies have sprung back into life in the past few trading sessions, with many of the major pairs breaking out of the narrow ranges that they have been stuck in for some time.
The most important announcement so far this week was undoubtedly Thursday’s policy decision from the European Central Bank. As anticipated, there was no change in rates, although President Lagarde did drop some hints that further cement our view that the first interest rate cut will most likely arrive in June. The ECB’s statement was little changed compared to January. It acknowledged that inflation had declined further, while saying that underlying inflation had moderated by most measures. At the same time, it mentioned that domestic price pressures ‘remain high, in part owing to strong growth in wages.
While the growth projections underwent went only minor tweaks (the 2024 forecast was cut to +0.6% from +0.8%), those on inflation were revised rather sharply. The bank now expects the headline inflation measure to average 2.3% this year (from 2.7%), before easing to 2% in 2025 (down from 2.1%) and to 1.9% in 2026 (unchanged). Perhaps the most important aspect of the fresh forecasts were the downward revisions to core inflation, which were cut to 2.6% this year (from 2.7%), 2.1% in 2025 (from 2.3%) and 2% in 2026 (from 2.1%).
Aside from the new macroeconomic forecasts, there were two key takeaways from Lagarde’s press conference. Firstly, she said the Council was in a ‘broad agreement’ that the bank will know ‘a lot more’ by June - we see this as the clearest indication yet that the central bank is eyeing the June meeting as the start date for the first-rate reduction. Secondly, she also noted that discussions on cuts were not had at this week’s meeting. Investors appeared to latch onto the latter, using it as a rationale to send the euro higher. However, in reality, we do not believe that this charges things too much, if at all. We would have been surprised had such discussions taken place, and the fact that they didn’t doesn’t necessarily make a June interest rate cut any less likely - indeed, this remains almost fully priced in by swap markets.
US dollar underperforms, as Fed Chair Powell hints rate cuts coming
Arguably the other big event in markets this week has been Fed Chair Powell’s semi-annual testimony to Congress. During his remarks, Powell noted that lower rates ‘would likely be appropriate this year’ should the US economy evolve as expected. While we don’t perceive Powell’s comments as overly dovish, investors have run with the idea that a June interest rate cut from the Fed is now firmly on the cards, which has triggered some dollar weakness against most currencies - some weak data on ADP employment and US job creation have not helped the dollar’s cause this week either. All attention now turns to this afternoon’s February NFP report.
The biggest winner among the major currencies on Thursday was the Japanese yen, which rallied back towards the 148 level on the broadly weaker greenback. Bank of Japan member Nakagawa indicated yesterday that the bank was moving towards its 2% inflation target, with reports suggesting that some members saw an end to negative rates as reasonable at the March policy meeting. These communications, and the hotter than expected Tokyo inflation numbers on Monday, has markets pricing in a 50/50 chance of an end to the bank’s negative rate policy as early as its 19th March meeting.
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Spring Budget announcement provides little surprises to GBP
Sterling took this week’s UK Spring Budget in its stride, but still managed to rally to its strongest position on the dollar so far in 2024, as investors sold the greenback en masse. Chancellor Hunt delivering no real surprises on Wednesday. As anticipated, National Insurance was cut by 2p to 8%, in unarguably the biggest headline of the day, while windfall tax on oil and gas was also extended. Practically everything else announced were both widely expected and constitute mere cosmetic changes as far as the broader UK economy is concerned. Importantly, there were no shocks when it comes to the Income Tax thresholds, which were left untouched. The latest growth forecasts from the OBR provide reason for cautious optimism, with modest growth of 0.8% seen in 2024, before expansion accelerates to 1.9% in 2025. We see these upward revisions as consistent with our modestly sanguine view on Britain’s economy. Investors seem to agree, and GBP is performing well as a result.
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