Three Central Banks, Three Rate Decisions: A Huge Week for FX

Last week was a telling one for currency markets, with the ECB choosing to raise interest rates by 25 basis points and, perhaps more importantly, leaving the door open to further tightening later this year. Interestingly, the decision did not provide the Euro with much of a boost. Part of the reason may be that the ECB is not raising rates from a position of economic strength, but instead reacting to renewed inflationary pressure, particularly from higher energy prices.

Later in the week we had US inflation data, with headline CPI rising to 3.4% year-on-year and core inflation coming in at 2.4%. We also had a positive surprise from the UK economy, with GDP growing by 0.4% in July against expectations for no growth. Much of that improvement came from the services sector, with computer programming and other areas benefiting from the continued investment surrounding AI. Sterling reacted positively to the numbers and finished the week in a stronger position.

This week could be considerably more important. We have interest-rate decisions from the Federal Reserve, Bank of England and Bank of Japan within the space of three days, alongside UK employment and inflation figures. By the end of the week we should have a much clearer picture of where interest rates are heading across three of the world’s major economies.

Monday is relatively light, with Canadian inflation the main release of note. The more interesting data begins on Tuesday with the latest UK labour-market report. Average earnings growth is expected to slow while jobless claims are forecast to rise, and there is also the possibility of a further increase in unemployment. The UK economy surprised positively with last week’s GDP number, but a weakening labour market would provide a very different signal and could put some pressure back on Sterling.

Wednesday is probably the biggest day of the week. We start with UK inflation, just 24 hours before the Bank of England makes its latest interest-rate decision. Core inflation is expected to rise to around 2.7%, while the monthly headline figure is expected to be broadly flat. With energy prices having risen again and the Bank already concerned about inflation becoming more persistent, any upside surprise will inevitably increase the debate around whether UK rates may eventually need to move higher again.

We also have Eurozone industrial production, which is expected to contract by around 0.7%. That will be worth watching after last week’s ECB decision. The ECB has just raised rates because of inflation concerns, but the underlying European economy is hardly booming, and weaker industrial data would highlight the difficult position policymakers now find themselves in.

The main event on Wednesday evening is the Federal Reserve. Following Friday’s inflation report, markets are now heavily leaning towards a 25-basis-point increase, which would take the Fed’s target range from 3.50%-3.75% to 3.75%-4.00%.

This is where Kevin Warsh’s approach to forward guidance makes things particularly interesting. We have had far less indication from the Fed about what it intends to do than markets have become accustomed to, so while a hike is now widely expected, there is still considerably more uncertainty around what happens afterwards.

The decision itself will obviously move the Dollar, but I think the press conference could be just as important. If the Fed raises rates and Warsh continues to focus on persistent inflation, markets will immediately start looking towards the possibility of another increase later in the year. If the hike is presented more as a precautionary move and the Fed remains cautious about doing more, the Dollar’s reaction could be very different.

For anyone with a sizeable Dollar requirement this week, I would be particularly careful about leaving everything exposed to Wednesday night’s decision. Tools such as limit orders and stop losses can be useful around events like this, particularly when we have less guidance than usual about how the central bank is likely to communicate its next move. If you would like to discuss how these work, feel free to contact me.

We then move almost immediately from the Fed into the Bank of England on Thursday. No change is currently expected, with Bank Rate at 3.75%, but I think the minutes and voting split will be more important than the headline decision.

The Bank is in an awkward position. Last week’s GDP figures were considerably stronger than expected, while inflation pressures from energy remain a concern. On the other side, Tuesday’s employment figures could show further weakness in the labour market. Governor Andrew Bailey has also pushed back against the idea that another rate rise is inevitable, so I don’t think we should assume that the BoE simply follows the direction being taken by other central banks.

Thursday’s meeting should therefore tell us more about how divided the MPC coverage" class="tcb-autolink">Monetary Policy Committee has become. If more members begin voting for a hike, markets are likely to bring the possibility of another increase later this year more firmly into Sterling pricing. If the vote remains comfortably in favour of holding rates, the Pound may find it more difficult to benefit from the decision.

Finally, on Friday we have the Bank of Japan. A 25-basis-point increase to 1.25% is widely expected and the Yen has already strengthened considerably in anticipation of it. As with the ECB and potentially the Fed, that means simply delivering the expected hike may not be enough to generate another major move.

Instead, markets will be looking for confirmation that the BoJ intends to continue gradually tightening policy. Recent Japanese GDP figures were revised higher and real wages have improved, which has strengthened the argument for higher rates. If the Bank indicates that another hike is possible later this year or early next year, that could provide further support for the Yen. If it becomes more cautious after Friday’s move, some of the recent Yen strength could unwind.

By the end of this week we will have heard from the Fed, Bank of England and Bank of Japan, while also having fresh UK employment and inflation figures to work with. What makes it particularly interesting is that none of these central banks is dealing with an especially straightforward economic picture. Inflation is becoming a problem again, largely because of energy, but raising rates into economies that are showing pockets of weakness carries its own risks.

For Sterling, Wednesday morning’s inflation report and Thursday’s Bank of England vote should give us a much better idea of whether another UK rate hike is genuinely becoming more likely. For the Dollar, the question is increasingly moving away from whether the Fed hikes this week and towards what happens after it. And for the Yen, much of Friday’s expected move is already priced in, meaning the BoJ’s guidance could matter more than the 25 basis points itself.

It should be one of the more important weeks we have had for FX in some time, and I would expect plenty of volatility around all three decisions.

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