Dollar Weakens as Fed Turns Dovish, Eyes on BoE
What’s been happening?
Pound Sterling – UK Markets
The British pound took advantage of the dovish shift seen in both the European Central Bank’s and the Federal Reserve’s policy outlook and gathered strength against the euro and the dollar.
Ahead of the Bank of England’s critical policy announcements on Thursday, the currency largely ignored the inflation report on Wednesday. The UK’s Office for National Statistics reported that the core Consumer Price Index (CPI), which strips volatile food and energy prices, ticked down to 1.7% on a yearly basis in May from 1.8% in April and came in line with analysts’ estimate. Further details of the report revealed that the CPI and the Producer Price Index (PPI output) both came in at 2% in the same period to match market expectations and the Retail Price Index (RPI) remained unchanged at 3%.
“Falling fares for transport services, particularly air fares influenced by the timing of Easter in April, and falling car prices produced the largest downward contributions to the change in the rate between April and May 2019,” the ONS noted in its press release. “Partially offsetting upward contributions came from rising prices for a range of games, toys and hobbies, furniture and furnishings, and accommodation services.”
US Dollar – US Markets
The US Dollar Index snapped its 5-day winning streak on Wednesday amid the dovish change in the FOMC’s tone.
Following its 2-day meeting, the Federal Open Market Committee announced that it kept the benchmark interest rate unchanged at the target range of 2.25% - 2.5% as expected. However, the FOMC removed the phrase “patient” from its policy statement when regarding the future policy adjustments. “Uncertainties have increased regarding the outlook for sustained economic expansion," the statement read. Meanwhile, the updated economic projections, known as the dot-plot, revealed that one policymaker saw only one rate cut in 2019 and sevens policymakers saw 2 rate cuts as appropriate. The publication further showed that the Fed saw economic growth slightly stronger in 2020 while expecting the jobless rate and inflation to turn slightly lower when compared to March projections. Following the press release, the CME Group FedWatch Tool showed that markets were pricing a probability of an 89% rate cut in July compared to 68.5% seen on Tuesday.
During the press conference, Jerome Powell, Chair of the Board of Governors of the Federal Reserve System, noted that many participants saw inflation coming to target more slowly than expected and now saw a stronger case for rate cuts. Regarding the Trump administration’s trade policy, Powell said news about trade became an important driver of the market sentiment. When responding to a question about the possibility of a 50 basis points rate cut, Powell said they are not yet engaged with the question of whether a rate cut should be 25 basis points or 50 basis points.
Euro – European Markets
The shared currency recovered the losses it suffered against the dollar on Wednesday but fell to its lowest level in a week against the pound sterling. According to the Eurostat, construction output in the euro area contracted by 0.8% on a monthly basis in April and fell short of the market expectation for an increase of 1.1%. Earlier in the day, the European Central Bank reported that the current account surplus narrowed to €19.2 billion in April from €35.1 billion in March.
During an interview with CNBC, European Central Bank (ECB) Vice President De Guindos noted that risks surrounding the euro area were tilted to the downside and said that they will react if those risks start to materialize, reaffirming President Draghi's dovish stance with regards to policy outlook. "The ECB could opt for a “combination of actions” to restore inflation," De Guindos explained. "The ECB has a wide range of instruments - forward guidance, TLTRO, reinvestment of the maturities of our balance sheets — so there is an ample range of instruments that we could use, and QE is a part of them."
What’s coming up?
UK: The UK’s Office for National Statistics (ONS) will publish the retail sales data on Thursday ahead of the Bank of England’s monetary policy announcements. Markets expect the policy rate and the asset purchase facility to remain unchanged at 0.75% and £435 billion, respectively.
US: Weekly jobless claims and the Philly Fed Manufacturing Survey will be featured in the U.S. economic docket.
EU: The European Central Bank will release its monthly Economic Bulletin and the European Commission will publish its Consumer Confidence Survey later in the day.