UK Inflation Print Sees Sterling Recover Losses

Impact on GBP: Inflation confirms no cuts tomorrow

UK inflation for August came in perfectly in line with consensus this morning. Headline CPI was unchanged at 2.2% YoY, while the core index accelerated from 3.3% to 3.6% as expected. The closely monitored services inflation also accelerated in line with consensus, from 5.2% to 5.6%.

This morning’s numbers all but confirm that the Bank of England should keep rates on hold tomorrow.?There is a residual 6bp of easing price though for the meeting, suggesting a bit more room for short-dated Sonia swap rates to readjust higher, after falling throughout September.

The Pound is trading on the front foot after CPI data and may find a bit more support tomorrow. That said, the FOMC event today may be a bigger event for GBP markets. A 25bp cut can send GBP/USD back below $1.3100.

No Major Data

Impact on EUR: Correction today, but rebound later

There are no major data releases in the Eurozone today, and we expect EUR/USD to trade in tight ranges until the FOMC announcement this evening. The transmission channels from the Fed cut to EUR/USD are the USD short-term rate impact first, and the equity reaction second. If the Fed cuts by 50bp and markets read that as a panic move, USD weakness may be channelled via EUR, JPY and CHF, while higher-beta currencies (like NOK and SEK) may take a hit.

In our base case (dovish 25bp cut), EUR/USD moves back below $1.1100, but gradually recovers ground in the coming days. By the time the next big things happen in markets (US PCE, US jobs report), EUR/USD may be back at $1.1100-$1.1200.

On the ECB side, another hawkish-leaning Governing Council member, Gediminas Simkus, said that an October cut is unlikely. Markets are only pricing in 7bp, and we also expect the next reduction in December. That said, if the Fed cuts by 50bp today, there will be growing pressure on the ECB to frontload some easing as well.

No Major Data.

Impact on USD: We expect a dovish 25bp cut today

Today’s Fed rate decision (1900 BST) is as close as it gets. Markets have recently leaned narrowly in favour (65%-35% implied probability) of a 50bp cut rather than 25bp.?If they go for a?50bp cut, it may well?be the consequence of the market itself having given the Fed the last push to a larger reduction via dovish repricing. You can easily see the key risk for the Fed here: Chair Jerome Powell would need to provide solid macro justifications for a half-point move to avoid sounding too sensitive to market rate expectations. Incidentally, Powell would need to show the 50bp cut isn’t a “panic” move: i.e. the Fed is not overly worried about recession and the jobs market. Failing to offer such reassurance can cause turmoil in equities.

The market view is a?25bp move is slightly more likely. However, we believe the Fed would accompany a more cautious cut with dovish messaging. That could include a few members voting for 50bp and Powell opening the door to larger cuts ahead.?

A 25bp cut will likely lead to a Dollar rally due to a mechanical shift higher in the OIS curve. However, if we are right with our expectations of a dovish press conference by Powell, the Dollar may well struggle to hold on to gains beyond the very short term.

Data 19.00: Federal Funds Rate expected 5.25% from 5.50%, FOMC Economic Projections & FOMC Statement. 19.30: FOMC Press Conference.

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