EUR/GBP continues to range within well-defined 0.8380-0.8420ish parameters, as has been the case since last Wednesday. The pair trades higher by about 0.25% just to the north of 0.8400 on Tuesday, having risen from Asia Pacific levels in the 93.80s to match weekly highs in the 0.8420s before reversing lower again. Consolidative trading conditions in recent days reflect a broader lack of conviction amongst market participants as various themes such as BoE/ECB policy normalisation, economic performance and the impact of the pandemic are weighed against each other.
Tuesday saw the release of IHS Markit’s widely followed November PMI surveys for both the UK and Eurozone. Surveys for both regions were stronger than markets had been expecting, with composite PMI in the Eurozone unexpectedly rising to 55.8 from 54.2 in October and composite PMI in the UK falling much less than expected to 58.6 from 59.1. The Eurozone survey showed that, as a result of shortages, supply chain disruptions and higher energy costs, input inflation hit record highs and a record number of firms reported raising their own prices.
The strong and inflationary Eurozone PMI surveys were released alongside influential ECB governing council member Isabel Schnabel making surprisingly hawkish comments. She warned that inflation in the Eurozone would be higher than previously thought in 2022 and could stay above the ECB's target in the medium term. This supports the case for ending the PEPP in March despite the current Covid-19 wave, she added. According to ING, Schnabel’s comments “hint at how the ECB will try to cautiously join the exit lane” regarding ultra-accomodative monetary policy. Thus, the bank expects “the ECB to end PEPP in March 2022, introduce a new third transition purchase programme and to gradually move over to APP as the only asset purchase programme”.
Turning back to the UK PMI survey, it was not just the headline numbers that were strong. Businesses reported the fastest growth in new orders in five months, whilst (as was the case in the Eurozone survey) cost pressures were at record levels. IHS chief business economist Chris Williamson said that “a combination of sustained buoyant business growth, further job market gains and record inflationary pressures gives a green light for interest rates to rise in December”. He added that the data showed a “welcome pick-up in GDP growth after the slowdown seen in the third quarter”.
But UK money markets seemingly need more convincing. Three-month short sterling December 2021 futures (a proxy for where the BoE’s bank rate will be next month) pushed to close to seven-week highs on Tuesday at 99.80. That implies that short-term interest markets are only pricing about 10bps worth of tightening at the December BoE meeting or about a 66% chance that the bank hikes rates by 15bps. This time two weeks ago, markets were pricing a 15bps hike with certainty.
Waning confidence that the BoE might hike in December could reflect the slightly more dovish than expected tone adopted by BoE governor Bailey over the weekend, who said that inflation risks were two-sided. There were also comments from dovish leaning BoE member Jonathon Haskel this morning, who reiterated his expectation that inflationary pressures would ultimately prove transitory and conceded that, if the labour market remained tight, interest rates would have to rise. These comments did not impact sterling at the time.
Perhaps money market reluctance to price a 15bps rate hike from the BoE in December reflects concerns about the pandemic raging in Europe. According to ING, "the vicinity of the UK to the EU, where cases are rising dangerously and new restrictions are being discussed, maybe keeping a floor on EUR/GBP”. “Markets could be reluctant to speculate that the UK will be able to dodge another serious Covid wave” the bank added.
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