Euro soars on hawkish ECB minutes

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15 January 2018

thomasdodds

The main event of the week did not disappoint. The publication of the minutes from the December ECB meetings showed that the Governing Council is leaning towards ending the monthly purchases of sovereign bonds after the current extension ends in September of this year. The news that Germany was close to a Grand Coalition agreement just added fuel to the euro rally, which pushed all European currencies higher on its wake.

T
he action next week should be centered on emerging market currencies. On Thursday, we have an unusual number of central bank meetings on the same day: the Central Bank of Turkey, the South African Reserve Board, the Bank of Korean and the Bank of Indonesia. In G10 currencies it should be a relatively quiet week, however.

GBP

Sterling managed to keep up with the torrid euro rally against the US dollar. Strong news from both manufacturing and retail sales eased worries about any weakening of the British economy, and brought further Bank of England into focus. News that Spain and Netherlands were pushing for a soft Brexit in the negotiations also buoyed the Pound. On Tuesday, we get the critical inflation report for December. An upside surprise would force the market to further reprice expectations for hikes and send Cable to fresh post-Brexit highs.

EUR

The ECB minutes from its December meeting revealed a growing confidence in the economic outlook of the Eurozone. More controversially, they stated that “ultimately, the further absorption of slack should lead to upward wage and price pressures”.  This is yet to be seen in the key core inflation numbers, which exclude volatile energy and food items. These remain stuck below 1% in December, showing no sign that the positive economic environment is resulting in any wage or price pressures. Nevertheless, markets repriced the beginning of ECB hikes, bringing them forward into 2018 and boosting the common currency to a fresh three-year high.

USD

There were some rather strong economic surprises out of the US last week. Retail sales continue to grow at a very healthy 6% annualized rate. More importantly, it is starting to look  like the tight labor market is finally starting to push up inflation, as the core rate rose in December to an 1.8% annualized rate – not far from the Fed’s target. The market chose to overlook these bullish developments and the dollar struggled as traders focused on the hawkish ECB minutes. However, we now expect four full interest rates hikes from the Federal Reserve, vs none from the ECB. As the short-term differential across the Atlantic, it’s difficult to see how the Euro can continue to rally, particularly given the extraordinarily stretched positioning of traders, which are overwhelmingly long the currency.