Will the ECB take a pause? – Sterling Update

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GBP

It has been another challenging week for the pound. GBP/USD tested the water under 1.2500 for the first time in three months, as broader dollar strength dominated the price movement.

The pound has lost roughly 5% against the dollar since reaching a high of around 1.3140 in early July. GBP/EUR also drifted back below 1.1650 for a spell, having previously eyed a clean break over 1.1700.

Aside from the dollar dynamics, The Bank of England’s recent comments could also have contributed to the pound’s decline. The Bank’s Governor Andrew Bailey seemed to suggest earlier in the week that UK interest rate hikes may not need to continue while forecasting “quite a marked” fall in inflation throughout the rest of the year.

Bailey was speaking at a Treasury Committee hearing, alongside fellow MPC colleagues Cunliffe and Dhingra, when he told MPs that rates were “much nearer the top of the cycle”, and while previously there had been a clear need to raise rates, the Bank of England was “not in that place anymore”. Previously, markets had expected two more hikes this year, but the news seemed to push back market-implied expectations for future BoE rate hikes. The markets have priced in a 25bps hike at September’s rate decision at an 84% probability.

Incoming data coming out of the UK this week largely beat analyst estimates. There was a surprising rebound in consumer spending in the UK over the past month, with Retail Sales rising by 4.1%, according to data published by the British Retail Consortium (BRC) on Monday. The increase was boosted by spending on health and beauty products and followed a relatively poor July that was impacted by unseasonal weather and rain, deterring consumer spending.

Furthermore, UK Services and Composite PMIs came in above expectations. The UK Services PMI came in at 49.5, ahead of the expected 48.7, and the UK Composite PMI was 48.6, ahead of the 47.9 forecast. Although both sets of data represented respective seven-month lows, they avoided matching January 2023’s two-year low.

Next week is a busy one for the UK, with the latest GDP, unemployment and consumer inflation expectations set for release.

EUR

The euro has now been in decline for eight straight weeks against the dollar, with the pair registering a total fall of around 5% in the process, with the pair currently testing support at 1.0700. The two biggest drivers in the euro decline seem to be similar to the pound at the moment, with an uncertain outlook on rate hikes, driven by weaker incoming data, combined with a strong dollar performance impacting the single currency.

The outcome of next week’s ECB rate decision remains uncertain, with ECB President Lagarde recently avoiding giving markets any indication of whether the ECB will pause or opt for another 25bps hike.

However, many senior ECB officials have continued to highlight the possibility of further ECB rate hikes. Bundesbank President Nagel commented that it “would be wrong to speculate that an interest rate peak will soon be followed by cuts,” and fellow ECB member Klaas Knot suggested the markets risked underplaying the chances of a hike.

This is especially relevant when considering incoming data continues to reflect a more challenging economic backdrop, which suggests that the ECB could do well to continue raising rates. Among that data, another batch of weak-looking European services PMIs continued the downbeat trend, with Spain, France, Italy and the region as a whole missing estimates, although Germany matched expectations. The latest data also confirmed a 0.2% decline over the past month in regional retail sales and another decline in German factory orders. The latest EU growth figures also missed estimates, with GDP rising by a mere 0.1% during Q2, against an expected increase of 0.3%.

Next week, all eyes will be on the ECB, and markets will be looking at what the central bank has to say, as much as the outcome of the rate decision