05 December 2023

November Overview

Last month, we talked about the dollar's strength, a trend we'd been seeing throughout the summer and into the autumn, which was boosted by political uncertainty in the Middle East. 

Since the beginning of November, however, we've seen something of a turnaround with a meteoric 5.1% rise from the pound against the US dollar.

Two key factors seem to have driven this:

Interest rate forecasts in the US

The first has been bets on the US Federal Reserve cutting interest rates early in 2024. The likelihood of a US recession has increased, and inflation seems to be under control, with CPI coming in at 3.2%, edging significantly closer to the 2% target inflation level. 

This has led many to believe that the Fed could start cutting interest rates early in 2024 to stimulate economic growth and reduce the chance of a downturn. This risk of lower interest rates has weakened USD significantly.

UK Inflation

The second key factor has been the inflation forecast in the UK, with price rises potentially becoming stickier than previously expected. Although there have been no significant data releases, there has been plenty of survey evidence, such as a Lloyds Bank survey suggesting that the net balance of companies planning to lift prices in the coming year reached a new high of 61% from 59% the previous month. 

This sticky inflation outlook plays into the "higher for longer" interest rate forecast for the Bank of England and, therefore, bolsters GBP compared to its peers.

GBP/USD rose from 1.2101 to 1.2726 over the month, and GBP/EUR rose slightly from 1.1539 to 1.1601.

December Outlook

December is a much more macro-economic-focused month with many central bank meetings. The key dates are 13th and 14th December, where we see the US Federal Reserve, Bank of England, and European Central Bank all meeting within 24 hours.

Although we don't expect any interest rate changes, these events and how they affect the expectations can still cause volatility, as we have seen over the past month.

UK

UK data has been broadly positive, with GDP and labour market data beating expectations. However, UK inflation is looking stickier, with many surveys suggesting price rises will not slow as much as expected.

The combination of higher-than-expected UK inflation and economic stability could lead to higher-than-expected UK interest rates, which could indicate a stronger pound. 

The market doesn't anticipate any further interest rate rises in the UK but that they will stay "higher for longer". We'll likely have more insight into this narrative after the Bank of England's next meeting.

With sterling rising so quickly over the last month, many analysts have suggested the pound is now in 'overbought' territory. This could mean a swift rebound or correction is more likely if any upcoming data releases are perceived to go the 'wrong' way. 

UK CPI inflation is probably one of the riskiest events this month for both sides of the market and will next be released on 20th December. 

United States

The US is the opposite story to the UK in many ways, hence the big reaction in GBP/USD. US data increasingly points towards a 'hard landing,' which is the US Federal Reserve's way of saying the country is heading for an economic recession as a result of the rise in interest rates. Compared to the UK, Stateside, we're seeing lower-than-expected US inflation and economic instability, which could lead to lower-than-expected US interest rates and potentially a weaker USD.

However, inflation is now really under control in the US, and as a result, the market is now pricing in up to 5 interest rate cuts (i.e., 1.25%) in 2024. The US Federal Reserve meeting will undoubtedly be one to watch for a better understanding of whether a shift in monetary policy is coming soon. 

US CPI inflation and GDP figures, released on 12th and 21st December, respectively, will give colour to the economic picture and potentially shift markets, depending on the outcome.

Europe

Inflation data in Europe has also been falling faster than expected, with data from Germany, Spain, France, and Italy all showing lower-than-expected price rises. Eurostat's estimate for the whole region placed the annual CPI inflation rate at 2.4%, close to the European Central Bank's 2% target.

We will be keen to see the commentary from the European Central Bank meeting, as the market is now pricing in 4 interest rate cuts (i.e., 1%) in 2024.

This commentary does not constitute financial advice and all quoted rates are sourced from Bloomberg.

Author 

- Joe Calnan, Corporate Dealing Manager