The Bank of Japan dismissed market rumors about further adjustments in the yield curve control and left the policy unchanged today, disappointing recent yen buyers. The Bloomberg report released yesterday about the ECB plans to execute more caution in the rest of the tightening cycle caused brief market embarrassment sending EURUSD to 1.08 and below, but later, as expected, bearish mood proved to be transitory. The dollar index, following a week of consolidation, traded below 102 points on signals of the growing slack in the US economy.
Dollar sentiment began to deteriorate yesterday after release of the Empire State manufacturing index. The headline reading plunged to -32.9 points vs. -9 points forecast, indicating a significant decline in business activity in the sector. The auction of 3- and 6-month Treasuries showed strong demand yesterday, indicating investors’ preference to buy more fixed income in anticipation of weakening activity in the US, which should obviously be reflected in softer inflation figures.
The greenback buyers who bet on a rebound after consolidation faced strong headwinds after the release of the key for this week US eco reports. The US retail sales report and PPI released today were noticeably worse than expected:
Basically, dovish surprise in key consumption component and business activity prompted quick revision of the US inflation forecast towards a faster decline and less hawkish Fed in 2023. The market reaction was clear: sell the dollar and bid stocks and bonds. As mentioned earlier, the dollar index fell below 102 points, while the US futures posted a moderate increase within 0.5%. A significant reaction was observed in Treasuries – the yield on 10-year bonds fell to 3.45%, and two-year – to 4.08%. EURUSD broke through 1.0850 and the breakout of 1.09 is next, followed by a move towards 1.10, where the main resistance is expected:
Yesterday was a day of controversial headlines for the euro. In a lengthy interview with the Financial Times, Chief Economist Philip Lane provided detailed arguments in support of the ECB’s recent hawkish rhetoric. Later in the day, however, a Bloomberg report quoted some ECB officials as saying that members of the Governing Council were actually considering a slower tightening (25bps). On this news, EUR/USD fell below 1.08, but today’s data on the US formed the counterbalance and the pair quickly recovered.
This morning data on the consumer price index for December were published in the UK, which generally coincided with the consensus forecasts. Headline inflation fell from 10.7% to 10.5%, while core inflation remained at 6.3%. The peak appears to be behind us and the headline inflation in the UK could return to 6% in the summer and 3.5-4% by the end of the year.
It is important to note that the rise in prices for core services accelerated from 6.4% to 6.8%, which the Bank of England should especially take into account, and when added to yesterday’s wage data, the balance of risks should shift upward to a possible 50 bp tightening in February.
The EUR/GBP pair returned to pre-Christmas levels below 0.8800 thanks to some peculiar lagging of the euro and support of the pound. As discussed above, ECB-related euro weakness may not last long and EUR/GBP may struggle to trade sustainably below 0.8800 for now, also given the absence of strong bullish forces in the pound.