Last night, the Federal Reserve (Fed) signaled that asset purchases would likely be tapered from November. Interest rate projections were more hawkish than expected too, but Fed Chair Jerome Powell downplayed this hawkish shift, delinking tapering from a rate-lift off. Overnight the US dollar index, a measure of the dollar strength against a basket of currencies fell away from month highs, allowing EUR/USD to cling onto $1.17.
The Fed’s dot plot – officials interest rate projections – showed the median rate expectation for 2023 moved up from two hike (forecast in June) to three hikes followed by three more hikes in 2024. Meanwhile, Fed officials were evenly split 9-9 on a rate hike in 2022, which would usually have strengthen the dollar. However, Chair Powell maintained an overall dovish tone coupled with the downgraded growth forecasts from 7% to 5.9%, which kept the dollar at bay. Nevertheless, inflation forecasts were raised to 4.2% this year, which is more than double the 2% target the bank sets and if price pressures continue to persist, the Fed may be forced to tighten policy at a quicker pace, which would likely trigger risk aversion and boost dollar demand.
EUR/USD whipsawed during the announcement last night, falling briefly below the $1.17 handle before reclaiming once the news had been absorbed by markets.
The key event of the day is the Bank of England’s (BOE) monetary policy announcement at 12:00pm. No changes to asset purchases or interest rates are expected, but policy guidance and comments on the current bullish market pricing of rate hikes will be critical. The British pound could be volatile, but what will strengthen and what will weaken it?
As market pricing currently highlights - speculation has been rising that the BOE will lift interest rates as early as next February and once again by the end of 2022. If the BOE backs up this pricing, then the pound could enjoy a surge higher, extending north of $1.37 versus the USD and on towards the $1.38-$1.39 resistance zone. GBP/EUR could reclaim the €1.17 handle and go on to test €1.18 over coming weeks. On the flip side, if the bank remains cautious about rising inflation, slowing growth and a possible spike in unemployment after the UK furlough scheme ends this month, then the pound could tumble sharply. In this scenario, GBP/USD could break below the $1.36 handle and GBP/EUR under €1.16 – both moves would increase the risk of an extended slide in the short-term.
Within the BOE, there are certainly divisions on when to tighten policy. Will the two new voting members lean towards the hawkish side and join Michael Saunders in halting asset purchases? If so, this would be constructive for the pound.
The Canadian dollar is continuing to find support in oil prices trading hands at $71 a barrel, and weakness in the greenback. Disappointing retails sales in Canada showed sales contracted by 0.6% today for the month of July. However, the loonie is unfazed by these results and finds support in the weaker greenback. The next data release which should give the BOC direction in terms of strength in Canadian economy is the unemployment rate (Oct 8th). Previous data showed the rate fall 0.4 percentage points to 7.1% in August. A decrease in the unemployment rate is seen as positive for the Canadian dollar.