Monetary policy meetings and interest rate hikes – Will the Pound weaken further this week?

The week ahead will be a major one for the Pound, Euro and US Dollar will all three respective central banks announcing further developments in their battle to reduce inflation back to target levels, through their monetary policy meetings this week. Monetary policy meetings and decisions on interest rates help us to understand the current health of the economy, which is the main influence on a currency’s value and, any adverse movement away from the expectation within the market, may result in volatile movement.

The Pound lost ground last week temporarily last week off the back of weak goods price and economic output data, both underwhelming expectations, but the main contributing factor against the Euro were the hawkish announcements from several European Central Bank members, leading to this week’s meeting. ECB members Joachim Nagel, Gabriel Makhlouf and Boštjan Vasle all agreed last week that the central bank will need to raise interest rates at this meeting, and meetings after that in order to bring inflation back down to the target level of 2%.

The latest reading of inflation was measured at 9.2% in January, down from 10.1% in December, but the reason for such a sudden drop was some member government’s intervention on energy prices, helping reduce such an impact over the winter months. Core inflation within the bloc continues to grow and the President of the ECB, Christine Lagarde, was also assured of upcoming interest rate hikes as the answer in her most recent speech last week. “We have made it clear that ECB interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive, and stay at those levels for as long as necessary,” Lagarde said. The ECB, and Lagarde specifically, have a reputation for being more dovish than other central banks but, if these comments are reflected in this week’s meeting, then we can expect a more bullish and positive approach moving forward.

The Bank of England are expected to have more of a cautious tone as they navigate their best route of bringing inflation back to target levels. The Consumer Price Index readings, in other words inflation levels, have steadily begun to drop over the past few months, from 11.1% in November to 10.5% in January. This will put less pressure on the central bank to raise interest rates largely at this meeting, or act more aggressively with future decisions, as their target is gradually being achieved.

Governor of the BoE, Andrew Bailey, recently discussed the generalised prediction within the market of peak interest rates at 6%, and commented that they were way too high. With the current bank rate sitting at 3.5%, expectation in the market is that the peak will now sit nearer to 4.5% in the months to come. Bailey did also, however, discuss the potential upcoming recession, predicted as the longest recession in 100 years by the Bank itself, and did so in a more positive light: “It has unfortunately got the characteristic of being long, but shallow. I would say that energy prices have come down so that ought to be a positive.

We have lower gas and oil prices and that will help to alleviate that real income shock somewhat. The market interest rate curve has come down, the exchange rate has strengthened a bit which will help a bit in terms of its pass through to inflation. So, there are those contributing factors and we will have to do the analysis over the next couple of weeks (next monetary report) to see what we turn those into.” 2 out of 9 members of the BoE voted for the interest rates to remain unchanged at the last meeting in December, so could we see more members begin to follow suit in fear of a recession on the horizon, or will the Bank’s comments provide support to the Pound instead as inflation continues to drop?

The US dollar has benefitted from the most aggressive policy tightening path in four decades in the US, as well as risk on sentiment within the global economy in 2022, and is now beginning to lose footing against a basket of major currencies in recent weeks. Cable rose 6 cents in January, with Euro also gaining 5 cents against the greenback within that timeframe, as the Federal Reserve head towards their monetary policy meeting on the first day of February. After two 75 and one 50 basis point hikes in recent months, there are speculations within the market of a more modest rate hike to give inflation time to decrease as monetary policy lags behind, and not drive the economy into an unnecessary recession in moving too aggressively.

CPI readings in the US peaked at 9.1% in July and have dropped to 6.5% in the most recent announcement, which displays the effect the quickened pace of interest rate hikes may have had on the market. Jerome Powell, Chair of the Federal Reserve, stood firm on the central bank’s policy for 2023, however, in a speech to kick off the year. “…restoring price stability when inflation is high can require measures that are not popular in the short term as we raise interest rates to slow the economy. The absence of direct political control over our decisions allows us to take these necessary measures without considering short-term political factors.”

Will the dollar gain back its recent losses? Can the Euro continue on its more positive start to 2023?

Key dates this week:

Mon – German GDP figures
Tues – German Retail sales & CPI figures, Eurozone GDP
Wed – Eurozone CPI, US Manufacturing PMI & Fed interest rate decision
Thurs – ECB and BoE interest rate decisions
Fri – Nonfarm payrolls US

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