The exchange rate between the pound and the dollar (GBP/USD) jumped above 1.1700 and posted a 10-week high above 1.1770 on Friday before a limited correction.
The exchange rate between the pound and the euro (GBP/EUR) strengthened to 1.1480 before correcting to 1.1435.
Global asset prices surged after the latest inflation data from the United States.
The headline inflation rate in the United States fell to a 9-month low of 7.7% from 8.2% and below expectations of 8.0%, while the base rate fell to 6, 3% versus 6.6%.
The data reinforced optimism that inflation had peaked. In response, markets scaled back expectations for future Fed rate hikes, expecting rates to be raised to 4.5% in December from 4.75% before the data, and the peak in US rates should now be below 5.00%.
Risk appetite rebounded strongly with equities soaring as the dollar posted steep losses.
The weakness in the dollar directly boosted the pound and the surge in risk appetite also provided net support for the pound.
Markets recalibrate Fed policy trajectory
The euro to dollar (EUR/USD) exchange rate jumped to 3-month highs above 1.0250 on Friday as the dollar posted steep losses.
The policies of the Federal Reserve and the trend of the dollar will be hotly debated.
According to Carol Kong, strategist at Commonwealth Bank of Australia; “A currency strategist at I think the US CPI results for October will support the case for a downward revision to the FOMC rate hike in December.”
Socgen considers the dollar to have peaked and EUR/USD to bottom with room for further gains; “Despite the energy crisis and pessimism regarding the conflict in Ukraine, inflation and growth, the bottom in EURUSD is likely behind us and midrange targets can be attacked.”
He added; “The pair should rise slightly towards projections of 1.0285 and the August high of 1.0360/1.0450, which is also the 200-DMA.”
ING does not expect dollar losses to continue; “We remain reluctant to get into the broader bearish dollar story at this time.”
The bank expects the Fed to be reluctant to take a dovish stance without stronger evidence, especially with a tight labor market.
It also considers that there is still a lack of attractive alternatives to the dollar.
Rabobank added; “The USD may be approaching the final stages of its rally, but we consider it far too early to expect the USD to change course.”
Queen’s funeral hurts September GDP
UK GDP was estimated to have shrunk by 0.6% in September, a steeper than expected decline of 0.4% for the month.
The August decline was revised to 0.1% from the 0.3% originally reported.
In this context, the contraction of GDP in the third quarter was contained to 0.2% against expectations of a fall of 0.5%.
GDP is estimated at 0.2% below February’s pre-pandemic level.
Activity in the services sector fell 0.8% for the month after falling 0.1% in August with a second straight sharp drop in consumer services output falling 1.7% after a contraction of 1.6% in August.
Industrial production increased by 0.2% on the month, with a growth of 0.4% for the construction sector, manufacturing being unchanged on the month.
ONS Director of Economic Statistics Darren Morgan said: ‘With September showing a notable decline partly due to the effects of the additional bank holiday for the Queen’s funeral, overall the economy has shrunk slightly in the third quarter.”
He added; “The quarterly decline was led by manufacturing, which saw widespread declines across most industries.”
The UK faces a prolonged recession
Resolution Foundation Research Director James Smith commented; “Slumping consumer spending caused the economy to contract in the third quarter of 2022. This put Britain on course for the fastest return to recession in nearly half a century.”
He added; “These latest figures provide a sobering backdrop to next week’s Autumn Statement. The Chancellor will need to strike a balance between putting public finances back on a sustainable footing, without further deepening the cost of living crisis. , or touch already overloaded public services.
Kitty Ussher, chief economist at the Institute of Directors, noted that the weakness was spreading; “The slowdown is now spreading across the economy with contractions in B2B sectors, such as information and technology and professional science activities, now joining existing difficulties in retail and manufacturing. “
PwC’s chief economist, Barret Kupelian, expected a prolonged downturn; “The overall dynamics of economic activity in the UK are also concerning. Inflation remains high, financial conditions are tightening at a rapid pace and there is strong potential for government spending cuts in the autumn statement of next week. These will all be significant headwinds for future growth.
According to Yael Selfin, chief economist at KPMG UK; “The current slowdown is expected to last until the end of 2023, during which time GDP is expected to decline by 1.6 percent.”
Paul Dales, chief UK economist at Capital Economics, noted the potential for brief relief for October, but added; “The fourth quarter is also the time when the brake on high inflation will be particularly important and when the cumulative effect of rising interest rates will strengthen. We believe these effects will mean that GDP will continue to decline for about a year, causing GDP to decline by about 2% from peak to trough.
Dales expects further but more limited BoE rate hikes; “None of this will stop the Chancellor from tightening fiscal policy next Thursday or stopping the Bank of England from raising rates above 3%. We still think rates may need to rise to 5 %, although tighter fiscal policy may reduce the need to raise rates quite far.
CBI Chief Economist Alpesh Paleja noted the government’s tough choices; “Weaker growth prospects and persistently high inflation will make some economic policy decisions difficult. The Autumn Statement should draw lessons from the 2010s: fiscal sustainability and higher trend growth are two immediate priorities. »
Thomas Pugh, RSM’s UK economist, added; “We expect Chancellor Hunt to impose around £50billion in tax hikes and spending cuts, which means public consumption will start to dampen GDP while the huge rise in the cost of Corporate borrowing will weigh heavily on investment.”
He added; “Furthermore, a global economic downturn means that large increases in export volumes are unlikely to continue. All of this suggests that GDP contractions are not only likely to continue, but will worsen in the first half of next year.
Samuel Tombs, chief UK economist at Pantheon Macroeconomics, noted the global comparison; The British economy is the only one in the G7 to have seen its GDP fall quarter on quarter in the third quarter. Britain is also the only G7 economy where the quarterly GDP measure has yet to return to its fourth quarter 2019 level. What the fuck.”
Pending financial statement; ING commented; “Above all, we will seek details on how the government will make its energy support less generous from April, which is most likely to reshape the outlook for 2023.”
The government said it would move to more targeted support, but there were no further details.
ING added; “The sharp drop in wholesale gas prices could see most households paying £3,300 on average in financial year 2023, compared to £2,500 a year under the government guarantee. That would equate to around 9% of household disposable income and further dampen overall economic activity next summer. »
ING added; “The domestic situation for the pound remains uncertain at best, and we believe this puts the GBP/USD pair at risk of fairly rapid corrections if support from a weaker dollar evaporates.”