Sample Category Title

Key Highlights

• USD/JPY is facing resistance near 148.50 and 149.00.
• A major bearish trend line is forming with resistance near 148.40 on the 4-hours chart.
• EUR/USD and GBP/USD gained bearish momentum below 0.9850 and 1.1320 respectively.
• The US nonfarm payrolls could increase 200K in Oct 2022, down from 263K.

USD/JPY Technical Analysis

The US Dollar attempted a fresh increase from the 145.50 support zone against the Japanese Yen. USD/JPY climbed above 146.50, but it faced a lot of hurdles.

Looking at the 4-hours chart, the pair climbed above the 147.00 level, the 100 simple moving average (red, 4-hours) plus the 200 simple moving average (green, 4-hours).

However, the bears were active near the 148.50 zone. There is also a major bearish trend line forming with resistance near 148.40 on the same chart. A clear move above the trend line resistance could open the doors for more upsides.

The next major resistance may perhaps be near 149.50. Any more gains could set the pace for a move towards the 151.20 level, above which it could even test 152.00.

An initial support is near the 147.00 level. The next major support is near the 146.50 zone. The main support sits at 145.50 zone or the 200 simple moving average (green, 4-hours).

The stated 145.50 support acted as a strong barrier and prevented downsides on three occasions. Therefore, a close below the 145.50 level and the 200 simple moving average (green, 4-hours) could increase selling pressure. In the stated case, it could decline towards the 142.00 support.

Looking at EUR/USD, the pair gained bearish momentum below the 0.9850 support. Similarly, GBP/USD declined below the 1.1320 support.

Economic Releases

• US nonfarm payrolls for Oct 2022 – Forecast 200K, versus 263K previous.
• US Unemployment Rate for Oct 2022 - Forecast 3.6%, versus 3.5% previous.
• Canada’s employment Change payrolls for Oct 2022 – Forecast 10K, versus 21.1K previous.
• Canada’s Unemployment Rate for Oct 2022 - Forecast 5.3%, versus 5.2% previous.

Key insights from the week that was.

The past week has seen a flurry of central bank communications as the RBA, FOMC and BoE all met to deliberate on policy. Evident In their decisions and commentary is a growing divergence in expectations around inflation and the risks to the policy outlook.

Despite the much stronger than expected Q3 CPI report, the RBA delivered only a 25bp hike at its November meeting. However, their revised forecasts for inflation in 2022 and 2023 (from 7.8% to 8.0% for 2022 and 4.3% to 4.75% for 2023) highlight the current strength of price pressures in Australia and their expected persistence. Consequently, we remain confident in our peak of 3.85%, with 25bp increases to be delivered in December, February, March and May.

Following the RBA’s decision, Chief Economist Bill Evans provided a detailed analysis of the outcome as well as the implications and risks. Note, as we go to press, the RBA’s latest Statement on Monetary Policy has also just been released, giving full detail on their own expectations regarding the outlook and risks.

This week’s Australian data flow meanwhile largely focused on housing. CoreLogic’s 8 capital city measure reported a 1.1% fall for October, leaving prices 6.6% below their peak level. The pace of price declines slowed in Sydney and Melbourne, but accelerated in Brisbane. Adelaide and Perth continue to show resilience, although prices are also beginning to slip there. Dwelling approvals meanwhile saw a material 5.8% decline in September following a number of upside surprises, with the weakness broad based. Ahead, further significant declines are expected, with affordability; the cost and availability of inputs; and general economic uncertainty all set to weigh on activity. This deterioration in new activity will feed through to GDP as well as the demand for housing credit. Note, at September, housing finance approvals were 26% below their peak of early 2022.

This week we also received an update on Australia’s trade position. September’s report was a positive surprise for exports which gained 7% on resilience in commodities and another strong showing for services. However, imports also faired better than expected. While the Q3 surplus of $30bn is another strong result, it is down from $44bn in Q2. Factoring in our expectations for price changes, this points to net exports’ contribution to GDP growth swinging from +1.0ppts in Q2 to -0.75ppts in Q3.

Before moving further afield, it is also worth highlighting that New Zealand’s labour market showed resounding strength this week, with the unemployment rate remaining near its record low in Q3 as employment grew rapidly. Wages also showed strong momentum, the labour cost index gaining 1.1% in Q3 to be 3.7% higher over the year. These results argue for an outsized 75bp increase in the cash rate at the RBNZ’s November review, in line with Westpac’s existing expectation. A peak of 5.0% is seen for the cash rate in 2023.

Turning to the UK. After a few tumultuous weeks in politics and markets, the Bank of England delivered a 75bp rate hike in November, raising the bank rate to 3.0%. While this represents strong progress towards tackling inflation, the Committee’s rhetoric and projections surrounding the economic and policy outlook has clearly shifted into more ‘dovish’ territory. Indeed, based on the market-implied path for the bank rate, the UK economy is expected to remain in a deep and prolonged recession through to H1 2024, coinciding with still elevated consumer inflation and a material weakening in the labour market, with the unemployment rate expected to almost reach 6%.

Reflecting on this, Governor Bailey emphasised in the press conference that market pricing has gone too far. A subsequent scenario analysis involving fixed policy at the current rate of 3.0%, albeit still bleak, produced a shallower recession and an inflation rate closer to the 2% target. On balance, inflation is still far too high and interest rates must rise further, but a slowing in the pace of rate hikes is very likely. Hence, we expect only 100bps of tightening remains in the cycle, bringing the bank rate to a peak of 4.0% by March 2023.

Finally then to the US. Already fully priced, the FOMC’s decision to raise by 75bps in November was looked through, with participants instead focused on the detail and tone of the Committee’s guidance. The take home point from the statement and press conference is that, while the FOMC is close to throttling back on the pace of rate hikes (our baseline expectation is for a 50bp hike in December and 25bps in January), with inflation risks still skewed upward, the FOMC believe they have more work to do before the hiking cycle concludes.

While we believe inflation will continue to decelerate through 2023, there is a question as to how patient the FOMC is willing to be in assessing the cumulative economic effect of policy tightening. Also critical will be how market participants price expectations for growth and inflation into nominal and real yields.

Clear from Chair Powell’s remarks is that the Committee is intent on maintaining tight financial conditions until the risks around inflation subside. This requires real yields to remain materially above zero. Implicit here is that, if real yields decline in the months ahead, the FOMC may look to continue tightening towards mid-2023 beyond our current peak of 4.625% at January/February 2023. Rate cuts are expected to remain off the FOMC’s agenda until 2024.

The risk for the US is clearly that this tight stance of policy leads to recession and/or a prolonged period of sub-trend growth, even after rates begin to decline in 2024. Our growth forecasts and expectations are laid out for the US and the world in our just released November Market Outlook on Westpac IQ.

The Reserve Bank has released its November Statement on Monetary Policy (SoMP).

The highlight of these Statements is the Bank's revised forecasts for growth, unemployment and inflation.

These forecasts are based on a path for the cash rate broadly in line with expectations derived from surveys of professional economists and financial market pricing (most likely a straight arithmetic average). Exchange rates and oil prices are also assumed to be unchanged through the forecast period.

This approach to cash rate assumptions can lead to some tensions. The forecasts are based on what the market and analysts expect for the policy instrument rather than what the Bank expects it needs to do. The risk with such an approach is that the Bank's forecasts are consistent with market pricing but may not be consistent with the Bank's own objectives. There is some evidence of this conundrum in the revised inflation outlook.

Forecasts are provided out to December 2024.

Due to the surprise lift in inflation in the September quarter inflation report, the Bank has raised its forecast for headline inflation in 2022 from 7.8% in the August SoMP to 8%. The forecast for inflation in 2023 has been lifted from 4.3% to 4.7% while 2024 has been lifted from 3% to 3.2%.

That means that the Bank is now forecasting inflation in 2023 to be much nearer 5% than the 4% we saw in August while it is clearly making the statement that it expects inflation will remain outside the 2-3% target range for three years. It is very rare for the RBA's 'out year' inflation forecast to be above its target range – the only other instances being when major tax changes were set to boost the CPI (the carbon tax in 2011 and the GST in 2000).

Psychologically, a 'near 5%' forecast rise for 2023 may lift expectations for both business and households, particularly with wage negotiations that are currently taking place. Negotiations may also be influenced by further progress in the proposed changes, which the government is now close to legislating, that would allow for industry-wide bargaining.

It is worth comparing the RBA's forecasts with those of its central bank peers. The 4.7% for 2023 is well above the RBA's 2-3% target. And while central banks in other developed economies are also expecting to miss their targets in 2023, they are plotting a clearer return to target in 2024.

The figure above shows the most recent inflation forecasts from other central banks in developed economies (noting that the RBNZ is likely to lift its forecast for 2022 and 2023 by around 0.2ppts when it updates its forecasts later this month due to a sharper than expected increase in September quarter inflation rise).

The figure clearly demonstrates that – at least in eyes of central banks – Australia's inflation picture is not more benign than in other developed economies. Inflation is also still rising in Australia (up from 7.3% in the September quarter), whereas most other developed economies are forecasting lower inflation by end 2022.

Other central banks are taking a more aggressive approach to rate rises. Markets and central bank guidance indicate that even for economies like Canada, New Zealand and the UK, which have higher household debt exposures to short term interest rates, the terminal policy rate is likely to settle at least 1ppt above the RBA's likely terminal rate.

The inflation forecasts for 2024 are particularly interesting: Canada (2.0%); New Zealand (2.2%); the UK (1.4%); and the US (2.3%).

These central banks are forecasting a much more emphatic return to target in 2024 than the RBA's forecast.

The more cautious approach from the RBA raises the prospect of a further entrenching a 'high inflation' psychology as businesses and households may doubt the RBA's commitment to returning inflation to the target zone. The Governor's statement that the Bank is aiming to return inflation to the target band "while keeping the economy on an even keel" contrasts with other central banks who accept the economic slowdown as the cost of containing inflation.

The Bank's growth forecasts are more in line with the likely economic cost of containing inflation.

The forecast growth rates have been lowered from the August numbers, particularly for 2023. Growth is forecast at 2.9% in 2022 (down from 3.2% in August); 1.4% in 2023 (down from 1.8%); and 1.6% in 2024 (down from 1.7%).

The major source of the downward revisions is household spending which was revised down from 2.4% growth in 2023 to 1.3% – in line with our forecast of 1.2% growth.

These overall growth numbers are getting closer to Westpac's forecasts in the out years (1.0% in 2023 and 2.0% in 2024). Our faster growth rate in 2024 relies on the RBA being in a position to cut rates by 100bps in 2024. If the RBA's inflation forecasts prove to be correct, it will be difficult to justify rate cuts as inflation will still be outside the target zone and the unemployment rate steady.

We expect the RBA will need to lift the cash rate to 3.85% in 2023 in the face of strong inflation with the last cut likely during the first half of the year (May).

Despite lower growth, the forecasts maintain that the unemployment rate will only rise from 3.5% (revised up from 3.4%) to 4.3% by end 2024 (lifted from the August forecasts of 4.0%). With slower growth in 2023 we expect that the unemployment rate will lift to 5.2% by end 2024.

Forecast wages growth in 2023 has been lifted from 3.6% to 3.9%, still benign but more in line with our own forecast of 4.5% reflecting the tight labour markets which are likely to persist through 2023.

The Overview section of the Statement does not provide any further insights into the decision process at the November Board meeting. It reiterates the points: that interest rates had already been increased significantly in a short period of time; that the effect is yet to be seen; that slowing the pace of tightening would allow more time to assess; that drawing out policy adjustments also helps to keep public attention focused for a longer period on the Board's resolve; and that the more frequent meeting schedule allows for smaller incremental changes. Going forward, all options are options on the table including moving in larger steps if necessary or even pausing for a period – the emphasis clearly being that policy is not on a pre-set path.

Conclusion

The revised forecasts in the Statement on Monetary Policy highlight the RBA Board's current expectation that it will not return inflation to the target zone until 2025 at the earliest. This contrasts with the more aggressive approaches of other central banks. The risk is that a 'high inflation' psychology emerges and is allowed to be sustained for longer, potentially making the challenge of bringing inflation back to target more difficult than necessary.

We agree with the downward revisions in the growth outlook for 2023, particularly with respect to household spending, but we expect the unemployment rate to increase further than indicated in the RBA's forecasts.

We remain comfortable with our call that the cash rate will increase to 3.85% by May next year, relying on steady 25bp moves.

The rate cuts we expect for 2024 are consistent with the very weak growth outlook for 2023 and 2024, which the Bank is close to franking, but the Bank's inflation forecasts would make it very difficult to deliver given inflation would be expected to hold outside the target zone.

Short term Elliott Wave view suggests correction from 9.28.2022 high ended at 109.53 as wave (4). Internal subdivision of wave (4) unfolded as a double three Elliott Wave structure. Down from 9.28.2022 high, wave W ended at 110.055 and wave X ended at 113.942. Index then resumes lower in wave Y to 109.53 and this completed wave (4) in higher degree. Dollar Index has turned higher in wave (5) but it still needs to break above previous peak on 9.28.2022 at 114.78 to rule out a double correction.

Up from wave (4), wave ((i)) ended at 111.78 and pullback in wave ((ii)) ended at 110.42. Index then resumes higher again and wave ((iii)) should end soon after a few more highs. Afterwards, it should pullback in wave ((iv)) to correct cycle from 11.3.2022 low before the rally resumes in wave ((v)). After wave ((v)) ends, the Index should complete wave 1 of (5). It should then pullback in wave 2 to correct cycle from 10.27.2022 low in larger degree 3, 7, or 11 swing before the rally resumes again. Near term, as far as pivot at 109.53 low stays intact, expect dips to find support in 3, 7, or 11 swing for further upside. Potential target for wave (5) higher is 123.6 inverse retracement of wave (4) at 114.78.

DXY 45 Minutes Elliott Wave Chart

Bank of England Review: A One-off 75bp Hike

• • In line with our expectation, the BoE today hiked policy rates by 75bp, bringing the Bank Rate to 3.00%.
  • We expect fiscal tightening and recession to weigh on the economy, which in our view, supports a slower hiking pace going forward.
  • We maintain our call for a 50bp hike in December and 25bp in February with risks to our call skewed towards additional hikes in 2023.

In line with our expectation, the Bank of England (BoE) hiked the Bank Rate by 75bp to 3.00% with 7 members voting for a 75bp hike, one member voting for 50bp and one member voting for 25bp. As expected, there was no news in regards to QT-communication as outright selling of government bonds commenced on 1 November.

Inflation forecasts were revised downwards across the line since the August meeting, as the Government's Energy Price Guarantee is set to lower and bring forward the expected peak of CPI inflation. The Bank now expects inflation to peak around 11% in Q4 2022 as "CPI inflation remains elevated at over 10% in the near term." On growth, the MPC's latest projections describe a very challenging outlook for the UK economy, where it now expects the UK "to be in a recession for a prolonged period." This supports our expectation of the Bank returning to a slower hiking pace as tighter financial conditions and the recession tear on the economy leaving a worsening growth outlook ahead. We thus keep the rest of our forecast unchanged, expecting a 50bp hike in December followed by a final 25bp hike in February 2023.

In terms of fiscal policy, we see an increased focus on closing the fiscal gap with the new government led by PM Rishi Sunak. We thus see fiscal policy as being less inflationary as expected under former PM Liz Truss. In turn, this could result in inflation becoming less persistent, which in our view makes a less aggressive rate path more likely. We receive further details in the governments Autumn Statement on 17 November.

Rates: Longer gilts ticked slightly higher on the announcement while the peak rate was pushed 10bp lower to 4.65% in June next year. Investors' took note of Governor Bailey comments that rates are to increase less than markets are currently pricing in noting that "best guess is closer to constant rate curve (3.0%) than market (5.25%)". Our base case remains that of a peak in the Bank Rate of 3.75%.

FX. EUR/GBP initially moved higher upon announcement to 0.8700 from 0.8650 and continued its move higher to 0.8730 during the press conference, as expected. We see a case for EUR/GBP to remain elevated in the near-term, but in the longer-term expect the cross to move lower as a global growth slowdown and the relative appeal of UK assets to investors are a positive for GBP relative to EUR.

Our call. We still expect BoE to deliver more rates hikes. We pencil in another 50bp rate hike in December and finally a 25bp hike in February. Our expectations fall below current market pricing (currently 245bps until June 2023) as we expect BoE to eventually turn less hawkish amid a weakening growth backdrop.

Markets

After the Fed, the spotlights redirected to the Bank of England. The central bank voted in a 7-2 decision to raise rates by 75 bps to 3%. The two defectors voted either for a 50 bps or 25 bps move. Its new forecasts are not yet calibrated to the formal medium-term fiscal statement (due Nov 17) but do take into account all government announcements up to and including October 17, amongst others the shortened period of the Energy Price Guarantee (EPG) to six months. The projections are conditioned on market expectations (through Oct 25) that see the policy rate go to 5.25% next year. If that were to happen, the UK economy would be in a recession for almost two years, the unemployment rate would surge to 6.5% and CPI, after peaking at 11% in Q4 this year (lower than projected in August thanks to the EPG), would drop to 1.5% in 2024 and 0% the year thereafter. In the alternative scenario of policy rates steadying at the current 3% rate, economic activity would be stronger but would still be falling at the end of 2023. CPI inflation is then projected to be a little above the target at the end of 2024 before falling more than a percentage point below the target in 2025. In the latter scenario, some more tightening is necessary while the former shows the BoE thinks markets were getting ahead of themselves. In unusually explicit wording, the policy statement says that further increases in Bank Rate may be required for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets. Governor Bailey repeated that later during the press conference, citing even “current” market pricing of 4.75%. UK money markets don’t buy Bailey’s guidance though and stick to a terminal rate between 4.5-4.75%. UK yields drop 3.5 bps at the front. The 10y yield rises 6.7 bps and the 30y even jumped >20 bps before cutting gains in half currently. Sterling loses out. The timing of the BoE’s dovish hike of course unfortunate, one day after uberhawk Powell. Dire growth prospects obviously don’t help sterling either. EUR/GBP advances from 0.86 to a test of the 0.872 resistance level. Cable (GBP/USD) drops from 1.1422 to 1.118.

Moves on other markets are still inspired by Powell. European stocks lose a percent while bourses in the US fall up to 1.2% (Nasdaq). Core bond yields add several more bps with Germany slightly underperforming the US. German yield changes vary between +7 bps (2y) to +9.1 bps (10y). Europe’s 2y swap yield is back at testing the 3% barrier. US yields add another 7.5 bps at the front (2y new cycle high) with more modest gains further out (1.9/4.8 bps 30y/10y). King dollar is unleashed. EUR/USD (0.977) risks losing its recently created upward trend channel already. The trade-weighted DXY steams higher to 112.9. The Japanese yen is surprisingly resilient.

In more central bank news today, the Czech National Bank kept rates steady at 7%. The move was expected. The CNB also decided that it will continue to prevent excessive fluctuations of the koruna exchange rate. This seemed to have squeezed out some who thought otherwise with EUR/CZK abruptly easing to 24.46 shortly after the announcement. A press conference is due later today. The Norges Bank lifted rates by a smaller-than-expected 25 bps move today. The policy rate now stands at 2.5%. In a very short policy statement, the NB pitted higher-than-expected inflation (6.9% in September) and a tight labour market against some areas in the economy cooling down and easing energy prices that may curb inflation ahead. Further tightening in December is likely though policy rate setting will be more gradual. The Norwegian krone loses in a kneejerk reaction. EUR/NOK headed to 10.33

News Headlines

Turkish inflation shows no signs of abating whatsoever. Prices went up by 3.54% m/m in October – another acceleration from the 3.08% the month before. Inflation soared from 83.45% to 85.51% y/y. Core inflation (ex food and energy) also accelerated from 68.09% to 70.45%. Of the main categories, transportation costs rose the most (117.2% y/y), followed by food and non-alcoholic beverages (99.1%). The October CPI reading is seen as the peak because of base effects kicking from this month on. With the central bank’s unorthodox policy – cutting rates despite skyrocketing inflation – real yields will remain deeply negative for a considerable amount of time still. The CBRT is expected to lower the policy rate (now 10.5%) one more time at the next meeting, to bring it into single-digit territory. The Turkish lira marginally strengthened following the release, which was slightly below analyst estimates overall. EUR/TRY is trading around 18.19.

With the Fed meeting out of the way, investors will turn to the latest US employment report that is out at 12:30 GMT Friday. Economists expect another solid nonfarm payrolls print, although there is some scope for disappointment according to business surveys. As for the dollar, while the outlook remains positive, we seem to be entering the ‘final act’ of this stunning rally. 

Fed vs economy

Despite a series of rapid-fire Fed rate increases this year, the US economy has not absorbed any serious damage yet. Many companies are struggling to access capital and demand is clearly losing steam as consumers get squeezed by the cost-of-living crisis, yet there have been no signs of mass bankruptcies or worker layoffs.

In the jobs market, this resilience is a story of policy lags and demographics. Historically, it takes several months before higher borrowing costs translate into job losses - employment is a lagging indicator. In this cycle, the lag has been exacerbated by migration trends. Net migration essentially came to a halt after the pandemic, so the US has experienced a huge shortage of workers that’s made businesses reluctant to fire staff.

Nonetheless, every leading indicator is warning of trouble ahead. Business surveys, inventory levels, consumer confidence metrics, and the inverted yield curve are all saying that a recession is imminent. The question is, when will all this be reflected in inflation and employment data? Those are the two areas where the Fed needs to see improvement before it backs off.

Markets are currently pricing in a peak rate of just above 5% after Chairman Powell stressed that he won’t reverse course at the first sign of trouble. He was adamant the Fed prefers a short period of economic pain, rather than several years of high inflation or stagflation.

Simmering down

Turning to the upcoming dataset, economists expect another decent report, with nonfarm payrolls set to clock in at 200k in October. While the unemployment rate is anticipated to tick up to 3.6%, this is still an extremely low number consistent with full employment. Wage growth is projected to lose some steam in yearly terms.

As for any surprises, the risks seem tilted towards a slight disappointment considering the signals from business surveys. Specifically, the S&P Global composite PMI revealed the first contraction in employment in two years, as companies started to play defense with workforce numbers.

That said, the ADP jobs print was solid at 239k, so the labor market is not falling apart either. It might take a few more months before any real weakness shows up.

In the markets, a relatively soft report could spark a round of profit-taking in the dollar. In this case, euro/dollar might edge higher towards the 0.9865 zone, which overlaps with the 50-day moving average.

On the flipside, another surprisingly strong dataset might add fuel to the latest move, pushing euro/dollar down for another test of the 0.9680 region.

Big picture

Overall, the outlook for the dollar remains positive, but we might be entering the final phase of this ferocious rally. The Fed has opened the door for smaller rate increases moving forward, ‘long dollar’ is already a very crowded trade, and the fundamentals of other major currencies have started to improve.

In Europe, the dramatic decline in energy prices means the winter might not be Armageddon after all, and any recession might be mild. In the UK, stability has returned with the entrance of the new government, while the Bank of Japan just signaled it might start normalizing policy.

The dollar could still hit new highs, especially in case a global recession hits, but the scope for further gains seems relatively limited. In other words, although the fundamentals still favor a stronger greenback, the risk-to-reward profile of chasing further gains from here is not attractive.

The US labor market has taken a bit of a back seat as the Fed focuses everything on getting inflation down. But, that might be about to change. There are some signs that traders need to be aware of for when the Fed might suddenly return to worrying about its second mandate. This is particularly relevant in the context where there is increasing speculation around when the Fed will start slowing its rate hikes.

As inflation was rising, the concern was that a price-wage spiral would develop. But for over a year now, wages have not even kept up with inflation, let alone pushing it forward. As higher interest rates bite, and more and more companies report that they will slow hiring, the next concern is when will the labor market flip. That is, more people seeking work than there are jobs for them.

Looking into the details

The latest BLS survey shows that there were 10.7M job openings in September. But there were only 6.1M seeking work. Despite there being over 4.6M jobs than there are jobseekers, there still hasn't been a major increase in average wages.  But, over the last couple of months, that gap has started to close. The ratio, on the other hand, has not, with the number of jobseekers to offers matching multi-decade lows. This reflects a trend where the number of job offers has been falling, and so has the number of people looking for work.

One of the assumptions over the last few months has been that as inflation rises, more people would be prompted to seek work. But the participation rate has remained stubbornly just above 62%, and is forecast to remain there in the latest data release. As long as the number of job openings remains above the number of unemployed, and the participation rate remains low, the jobs market is likely to remain off the Fed's radar.

What to look out for

Before the pandemic started, an NFP number of around 200K job adds was considered normal, and would be expected to keep the Fed happy. This time around, NFP are forecast to come in at 200K, down from 288K as last reported. The unemployment rate is expected to tick up to 3.6% from 3.5%, which could give some people deja vu from 2019.

But a deeper dive into the figures shows some worrying signs. The ADP jobs survey was released yesterday, and is still not considered predictive of NFP despite the new methodology. However, it does prove some interesting understanding of the jobs market, and what we might see in some of this month's NFP components.

The bottom line

ADP showed that the bulk of job creation was in the leisure and hospitality sectors, which is to be expected in the middle of summer. However, those jobs tend to be lower paid, and that likely contributes to the expected slowing growth in average hourly wages. That was also reflected in BLS data, showing that job openings increased in accommodation and food services, but declined in manufacturing.

In other words, the jobs market continues to be tight in the areas of lower skilled, lower pay. But people who wish to switch to higher paying jobs are starting to struggle. That doesn't mean the labor market is loose, but it could be soon.

Summary

• The Bank of England (BoE) raised its policy rate aggressively at today monetary policy announcement, raising its Bank rate by 75 basis points to 3.00%.
• However, there were also signals from the BoE that the pace of tightening will likely slow going forward. First, while all policymakers voted to raise interest rates, the size of the rate hike was not unanimous. The Bank of England also said policy interest rates could peak at a lower level than was priced into financial markets as of late October (albeit at the time that peak rate was expected to be around 5.25%).
• The central bank's updated economic projections offer a clear indication as to why interest rates could rise at a less rapid pace than previously. The central scenario based off market interest rates sees a protracted recession and inflation undershooting its target over the medium term. Even in a scenario where interest rates hold steady at 3.00%, CPI inflation is forecasted to be only slightly above target in two years time.
• With the prospect of further fiscal consolidation also potentially weighing on the growth outlook, we now forecast slightly less tightening from the Bank of England than previously. We expect a 50 basis point rate increase in December and a final 25 basis point increase in February next year. That would see the policy rate peak at 3.75%.
• The combination of a protracted economic recession and a central bank that under delivers versus the market's rate hike expectations are key factors behind our view of renewed sterling weakness into early 2023, with a targeted GBP/USD exchange rate of $1.0600 by the end of the first quarter next year.

Bank of England Delivers Jumbo Hike, Hints at Smaller Moves Ahead

The Bank of England (BoE) raised its policy rate aggressively at today's monetary policy announcement, raising its Bank Rate by 75 basis points to 3.00%. The increase matched the consensus forecast. However, there were also signals from the BoE that the pace of tightening will likely slow going forward. First, while all policymakers voted to raise interest rates, the size of the rate hike was not unanimous. Seven policymakers voted for the 75 basis point increase, while one voted for 50 basis points and one voted for 25 basis points. Second, the BoE offered updated economic projections conditioned on the market's interest rate expectations as of late October, which at the time saw a peak policy rate of around 5.25% by Q3-2023. In addition to raising interest rates and specifically referring to that 5.25% peak rate, the BoE said:

“Should the economy evolve broadly in line with the latest Monetary Policy Report projections, further increases in Bank Rate may be required for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets.”

The central bank's updated economic projections do not make pleasant reading, and offer a clear indication as to why the BoE believes interest rates could rise at a less rapid pace than previously. Higher mortgage rates and tighter financial conditions are expected to weigh on economic activity. And even though the energy price cap means inflation should peak at a lower rate than previously, elevated inflation is still expected to weigh on incomes and growth for an extended period. Against this backdrop, the BoE's central projections anticipate U.K. GDP declining for eight consecutive quarters, with a peak-to-trough decline of almost 3%. The BoE forecasts full-year 2023 GDP growth at -1.6%, and full year 2024 GDP growth at -0.9%. With respect to inflation, the BoE sees CPI inflation peaking at 10.9% year-over-year in Q4-2022, before slowing to 5.2% by Q4-2023 and 1.4% by Q4-2024.

The BoE's alternative economic projections, based on a constant policy rate of 3.00%, are also quite illuminating. Under that scenario, U.K. GDP is forecast to fall by a smaller 0.9% in 2023 and 0.2% in 2024. Meanwhile, CPI inflation is forecast to slow to 5.6% in Q4-2023 and 2.2% in Q4-2024. With inflation only slightly above target in 2024, even under an assumption of constant interest rates, it's possible interest rates may not need to rise too much further from current levels.

Softening Household Finances and Tightening Fiscal Policy to Weigh on the Economy

Recent indicators are consistent with the central bank's underwhelming growth outlook. The economy has already shown a clear loss of momentum during the third quarter, as a small 0.1% month-over-month increase in July GDP was more than offset by a 0.3% decline in August GDP. While the August weakness was concentrated in manufacturing, with industrial output down 1.8%, services activity also dipped by 0.1%. In addition, the economy appears to have continued softening into the fourth quarter. The October services PMI fell sharply to 47.5, the first sub-50 reading since February 2021, while the manufacturing PMI also declined to 46.2.

More generally, and as the Bank of England itself highlighted, softening household finances are likely to weigh on the consumer for an extended period. With price increases now outstripping income gains, growth in real household disposable incomes has turned negative for the past several quarters. Indeed, real household incomes fell 1.2% quarter-over-quarter in Q2, the fourth decline in a row, and are down 2.4% year-over-year. With CPI inflation having quickened further since, and given signs of slowing job growth (employment fell by 109,000 in the three months through August), further declines in real household incomes appear more likely than not.

Finally, the potential for fiscal consolidation could add to downside pressures on the economy and reinforce the downturn. The BoE's forecast incorporate the government's publicly announced fiscal initiatives as of October 17. These include a reversal of most of the proposals that were outlined in the Growth Plan in late September, as well as scaling back plans to cap energy prices for households. Previously the government said that energy prices would be capped for households for up to two years beginning from October 2022. However, new Chancellor Hunt subsequently said those plans would now only apply for six months through April 2023, with the intention to transition to a more targeted energy support package after that. However, media reports suggest the government will likely announce further fiscal consolidation measures at the Autumn Statement scheduled for November 17. Indeed, Prime Minister Sunak and Chancellor Hunt said it's inevitable all Britons will pay more in tax. Analysts have suggested the government will announce a further £40B-£50B (1.75%-2.00% of GDP) of annual savings in the Autumn Statement, initiatives that would pose downside risks to growth.

Thus, while the BoE remains concerned about inflation, we ultimately believe a sharp economic downturn will be the key factor that brings the central bank's policy rate increases to an early end, likely during the initial months of 2023. That would particularly be the case if CPI inflation shows signs of having peaked, or if there is a significant and sustained decline in wholesale energy prices. And with the prospect of further fiscal consolidation to be announced shortly, that could also rein in the extent of Bank of England tightening. In fact, following today's announcement we now forecast slightly less tightening from the Bank of England than previously. We expect a 50 basis point rate increase in December, and a final 25 basis point increase in February next year. That would see the policy rate peak at 3.75%, which is still well below the peak of around 4.65% forecast by market participants. The combination of a protracted economic recession and a central bank that under delivers versus the market's rate hike expectations are key factors behind our view of renewed sterling weakness into early 2023, with a targeted GBP/USD exchange rate of $1.0600 by the end of the first quarter next year.