Today, market participants will have their gaze locked on the Bank of England’s first "Super Thursday" of the year. Besides the policy decision and the meeting minutes, we will also receive the quarterly Inflation Report with updated economic forecasts for the UK economy, which Governor Carney will present at a press conference after the meeting. We think that the focus will be on the officials’ outlook for inflation following the latest acceleration in both the headline and the core CPIs. Both rates surged by more than expected in December and now stand at 1.6% yoy, close to the Bank’s 2% target. Considering how quickly these rates have risen in recent months, we expect investors to be on the lookout for any comments regarding the limits of the Bank’s willingness to "look through" above-target inflation. It would be interesting to see if Governor Carney is questioned on whether there is a specific CPI rate that the Bank considers as an unofficial "ceiling", after which it will consider tightening policy in order to curb inflation.
Overall, we expect a neutral tone from the BoE, indicating that policy can still respond in both directions if needed. At the same time, we think that the GDP forecasts are likely to be revised upwards, considering the strength in both UK economic indicators and more forward looking surveys, like the PMIs. At the same time, given sterling’s notable rebound since the latest Inflation Report, we see the case for a modest downward revision in the near-term CPI forecasts. Given our expectations for a neutral stance overall and positive revisions to the forecasts, we think that the path of least resistance for sterling may be to the upside, at least in the aftermath of the meeting.
GBP/USD traded higher yesterday, breaking above the resistance (now turned into support) of 1.2660 (S1). The move has confirmed a forthcoming higher high on the 4-hour chart and that the short-term trend is back positive. We now expect the bulls to target our next resistance of 1.2720 (R1), defined by the peaks of the 13th and 14th of December, where a clear break is possible to open the way for the 1.2770 (R2) barrier. Switching to the daily chart, even though the short-term trend appears to be positive, the medium-term path remains flat. The rate has been trading between 1.2100 and 1.2850 since the 4th of October.
Fed holds cards close to its chest; no new signals on policy
The FOMC kept borrowing costs unchanged yesterday, as was widely expected, and offered almost no new hints with regards to the timing of the next rate hike. Given that this was one of the meetings without a press conference or updated economic projections, the market action came from the changes in the statement accompanying the decision, or to be precise, the lack of any changes. The only material shift from the previous policy statement was an upgrade in the outlook for consumer and business sentiment, though this is a relatively minor improvement.
Perhaps due to the absence of any fresh forward guidance, the reaction in the dollar was somewhat negative. Overall, we maintain the view that as things currently stand, our base-case scenario is for the Committee to deliver only 2 hikes this year, in line with current market pricing. The excessive USD strength that three hikes could cause and a more dovish Committee this year in terms of voting rights, are factors that could lead to 2 hikes, and not 3 as currently projected by the "dot plot", we think. We would like to see a material pick-up in inflationary pressures, particularly in the core PCE price index, and some clarity around the government’s fiscal stimulus package, before we reassess this view.
As for the dollar’s path over the next few days, we remain cautiously optimistic, for two main reasons. Firstly, we think that tomorrow’s employment report may overcome market expectations, considering that the ADP report was particularly strong yesterday. What’s more, on Monday, we may get greater clarity with regards to the new administration’s fiscal plans, as the President is expected to submit a preliminary budget proposal to Congress. The preliminary numbers could shed some light into the government’s objectives, and thereby diminish some of the uncertainty around the US policy outlook.
EUR/USD tumbled yesterday after it hit resistance at the key barrier of 1.0800 (R1). Nevertheless, the slide was stopped by the 1.0740 (S1) level, and at the time of the FOMC decision, the rate rebounded. Now, it looks to be headed for another test near the 1.0800 (R1), where a possible break could prove a game changer. For now, we prefer to remain neutral as the bears may take charge again near 1.0800 (R1) and aim for another test at 1.0740 (S1). If they manage to overcome that support, we may have the completion of a double top on the 4-hour chart, and we could see initial extensions towards the 1.0685 (S2) hurdle.
Looking ahead though, the greenback’s outlook becomes more uncertain. We still believe that the dynamics of monetary policy divergence and increased fiscal stimulus, could be supportive for the currency. However, the recent verbal interventions from the Trump administration with regards to USD strength pose a significant risk to that view. Even though it remains to be seen which of these forces will drive USD in the longer term, we think that in the absence of any actions to back up the government’s comments, jawboning alone is unlikely to continue to weaken the dollar for much longer.
The price structure on the daily chart of EUR/USD is lower peaks and lower troughs since the 9th of November. As a result, as long as the recovery started on the 3rd of January remains limited below the 1.0800 (R1) zone, we would treat it as a corrective phase. We would like to see a decisive close above 1.0800 (R1) before we start reconsidering our analysis.
Today’s highlights:
In the UK, besides the BoE decision, the government is also expected to publish its "White Paper", a formal policy document that will set out its Brexit negotiating objectives. However, considering that this will probably be a formal reiteration of what PM May outlined in her Brexit speech on the 16th of January, we do not expect a major market moving reaction from this release.
As for the UK economic data, we get the construction PMI for January, though market focus is likely to be fixed on the BoE decision. In Eurozone, the PPI for December is due out and expectations are for a very sharp acceleration in producer prices.
From the US, we get the preliminary labor costs index for Q4 and the forecast is for a notable pick-up. At the same time, we get initial jobless claims for the week that ended January 27th.
Besides Governor Carney, we have one more speaker scheduled for today: ECB Executive Board member Benoit Coeure.
