On Tuesday we spoke about consumer price inflation and just how significant the fallout of variations in this statistic can be within the FX market. With particular reference to a 50% above-target reading in the US that had ramifications in the order of hundreds of billions of Dollars in the US economy, via the mechanism of interest rate expectations it was clear just how quickly currencies could move. Yesterday, three more currency areas released their own similar statistic. Those included, the UK, the Eurozone and Canada. In order to understand each reaction in the market it is critical to understand the context of the data release including existing pre-release inflation/interest rate expectations and the state of the economy with respect to its post-pandemic rebound.
In chronological order: In the UK, read at 7am yesterday morning, the statistic released was the year on year consumer price index proxy for inflation. The price level was expected to be read 3.9% higher as of October 2021 when compared with October 2020. What the market saw was inflation hit 4.2%, well above market expectations. UK rate expectations are relatively mature, behind that of the likes of Canada discussed below but ahead of those price in within the Eurozone. Having decided not to raise interest rates at their last meeting, pressure was already on before this release for the Bank of England to raise rates ahead of year end. This inflation reading has and will continue to put pressure on the bank to raise rates faster. This pushed sterling higher across the board up for a second consecutive day in the order of 0.3%.
Next, it was the turn of the Eurozone at 10am to release data. The Eurozone was also releasing year on year HICP (similar to CPI inflation data). The data had previously been estimated and forecast at 4.1%. As has been typical of the Eurozone and indeed any currency union, the inflation data is typically more moderated and slower to move. Accordingly, interest rate expectations were far less developed with little monetary tightening priced into the Euro. Those underwhelming expectations seem well placed with core inflation missing estimates to the downside by 0.1% yesterday. Given the outperformance in UK inflation and a miss in the Eurozone, it is easy to justify why GBPEUR yesterday hit highs not seen since before the pandemic took hold, and only exceeded in February 2020.
Lastly, at 1:30pm UK time, it was the turn of Canada. The case of the Canadian economy and its Dollar colloquially know as ‘Loonie’ is more complicated. Canada has highly developed interest rate expectations given the fundamentals of its economy and the fact that it has been one of the economies who has been looking at monetary tightening for the longest period of time post-pandemic. In fact, Canada even chose to end its QE program last month and ahead of the data release yesterday had 100 basis points (1%) worth of interest hike hikes priced into its forward curve next year. Data was expected to show year-on-year inflation at 4.7%. Inflation forecasts were satisfied in Canada yesterday, however the Canadian Dollar still suffered. This was because with the theme of inflation coming in above consensus forecasts, as seen now in the US and the UK, was not reflected within the Canadian economy, pricing out speculative positions looking for even stronger monetary tightening in Canada.
Discussion and Analysis by Charles Porter