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Euro advances to 8-month high on ECB policy outlook

Mon 24 July 2017

Highlights from last week:

  • Sterling/euro slumps to lows under €1.12
  • Euro surges as ECB hints at QE tapering
  • Inflation drop eases pressure on BoE to hike rates

The week ahead:

  • UK second-quarter GDP data (Wednesday, 9.30am)
  • Federal Reserve policy meeting (Wednesday, 7.00pm)
  • US second-quarter GDP data (Friday, 1.30pm)

View exchange rates and interest rates

Euro soars after ECB announcement

The pound slumped to eight-month lows approaching €1.11 last week, with the euro rallying after European Central Bank (ECB) President Mario Draghi suggested policymakers could start discussing a reduction to its quantitative easing (QE) policies in the “autumn”.

The ECB kept its main policy interest rate at 0%, whilst the existing asset purchase programme is intended to continue at a rate of €60bn per month until at least the end of this year. Mr Draghi struck a more optimistic tone on the euro zone’s economic prospects, highlighting that the region is finally experiencing a robust recovery despite inflation running under its ‘below but close to 2%’ objective. A key date for the calendar is the ECB’s next policy meeting on 7 September when the central bank’s updated economic projections will be published.

Unexpected fall in UK inflation knocks sterling

UK consumer price inflation unexpectedly dipped to an annual rate of 2.6%, from 2.9% previously, weighing on sterling as markets reflected on a lower likelihood that the Bank of England (BoE) might lift interest rates anytime soon. The fall provided tentative signs that the inflationary impact of last year’s post-referendum plunge in sterling’s value (which pushes up import costs) may be beginning to fade. However, it’s still too early to rule out inflation accelerating again in the coming months given the BoE’s latest inflation forecasts point to the rate peaking in the final quarter of this year. A 0.6% rebound in UK retail sales in June partially retraced some of May’s 1.1% drop, but failed to give the pound any meaningful lift.

Collapse of Trump’s healthcare bill weighs on dollar

Sterling initially rose to nine-month highs above $1.31 against the US dollar after continued divisions within the US Republican party meant a second attempt to pass the latest healthcare bill was abandoned. Two dissenting Republican senators saw the party’s latest efforts to replace President Obama’s healthcare system collapse, undermining President Trump’s wider economic agenda. Sterling weakness later pulled it back under $1.30 late in the week.

Interest rate outlooks boost Australian dollar but dent South African rand gains

Elsewhere, sterling found itself lagging behind most of its main rivals and slid to three-month lows under A$1.63 versus the Australian dollar. The Reserve Bank of Australia’s July policy meeting minutes sparked some speculation the central bank might begin lifting interest rates sooner than previously thought as it estimated the “neutral” official cash rate to be 3.5% - a full 2% higher than the current level. One encouraging area for the Australian economy since the start of the year has been a robust jobs market, although this is yet to exert significant upward pressure on wages. Whilst June’s employment rise was in line with expectations, a positive point was that gains were driven by new full-time jobs which more than offset a fall in part-time positions.

The Bank of Japan voted 7-2 to leave its monetary policy settings unchanged, as expected. The impact on the Japanese yen was muted, with the central bank revising its growth forecasts up but also suggesting it would take longer to push inflation up to its 2% target level. A surprise South Africa interest rate cut saw the South African rand temporarily pare some of its gains on Thursday. South Africa’s Reserve Bank cited a deteriorating growth outlook as it lowered its key policy rate by 0.25% to 6.75% - its first change in over a year.

The week ahead

On the domestic data front this week, Wednesday’s release of a first estimate of second-quarter UK GDP (9.30am) will take centre stage. The data provides an important update on the economy’s growth performance against the backdrop of heightened political uncertainty associated with an early general election and a tentative start to formal Brexit talks.

An advance estimate of the US economy’s second-quarter GDP (Friday, 1.30pm) is also a key event on a busy US data schedule. As ever, the outlook for US interest rates will potentially have an important bearing on the dollar’s performance and the Federal Reserve’s latest policy meeting announcement (Wednesday, 7.00pm) will be scrutinised for clues on timing of any future rate hikes. New home sales figures (Wednesday, 3.00pm) and durable goods orders data (Thursday, 1.30pm) will add some colour to the overall economic picture.

The euro zone economic calendar is very quiet and may therefore do little to sway sentiment towards the euro significantly. Consumer and business confidence figures are both due on Friday at 11.00am.

View UK, US and euro zone announcements with our economic calendar

Other key data releases:

German IFO business climate data (Tuesday, 9.00am)

Australian consumer price inflation data (Wednesday, 2.30am)

Japanese consumer price inflation data (Friday, 00.30am), unemployment data (Friday, 00.30am) and retail trade data (Friday, 00.50am)

Canadian GDP data (Friday, 1.30pm)

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