Central Bank Watch Overview:
- The BOE and the ECB are meeting later this month, but focus is on what they’ll do later this year and beyond.
- The BOE is further along the path of normalization, while the ECB is still toying with ideas about how it may further enhance its stimulus measures in context of rising inflation pressures.
- Retail trader positioningsuggests that EUR/USD has a mixed bias while GBP/USD has a bearish bias.
Inflation Making Central Bankers Uneasy
In this edition of Central Bank Watch, we’ll cover the two major central banks in Europe: the Bank of England and the European Central Bank. Neither of Europe’s most significant central banks won’t meet again until later this month, allowing for the EUR– and GBP-crosses to toy with speculation over forthcoming policy moves. And while one of the central banks has begun to throttle back its QE program, the other is grappling with its desire to provide additional stimulus against the backdrop of rising inflationary pressures.
For more information on central banks, please visit the DailyFX Central Bank Release Calendar.
BOE Keeping Calm, But Warns of Inflation
The BOE has already made the adjustment to its bond buying program so that it will no longer reach its £875 billion target in early-October. QE continues, but at a slower pace. But in recent days, BOE Chief Economist Andy Haldane has rung the alarm bell about inflation, suggesting that the BOE may have some more hawkish inclinations than what’s currently priced-in.
At a UK Treasury Select Committee hearing last week, the BOE’s chief economist said that “an upside surprise to inflation is among the greatest risks” as it would force policymakers “to tighten policy even more rapidly or on a more significant scale, or possibly both, in a way that would take the legs out of the recovery.” Stagflation, of course, is the concern here, leading to the classic catch-22: high inflation necessitates higher interest rates, which could lead to lower growth rates.
Bank of England Interest Rate Expectations (June 1, 2021) (Table 1)
If BOE Chief Economist Haldance is sounding the alarm on inflation, it makes sense that markets are taking it as a sign that the BOE may prove more sensitive to rising price pressures than other central banks and be quicker to act. According to overnight index swaps, while there is only a 3% chance of a 25-bps rate hike in 2021, there is a 33% chance of a hike over the next 12-months.
IG Client Sentiment Index: GBP/USD Rate Forecast (June 1, 2021) (Chart 1)
GBP/USD: Retail trader data shows 40.26% of traders are net-long with the ratio of traders short to long at 1.48 to 1. The number of traders net-long is 19.57% higher than yesterday and unchanged from last week, while the number of traders net-short is 8.85% lower than yesterday and 4.38% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests GBP/USD prices may continue to rise.
Yet traders are less net-short than yesterday and compared with last week. Recent changes in sentiment warn that the current GBP/USD price trend may soon reverse lower despite the fact traders remain net-short.
ECB Balancing Inflation Concerns
Since 2017, the ECB has defined its price stability target of achieving inflation “below but close to 2%,” which is why recent data may start to make some policymakers nervous. But after a decade following the Eurozone debt crisis of low inflation and meager rates of growth, it doesn’t seem likely that the ECB will act quickly to address what it has called transitory inflation, of which it has limited monetary tools to address.
Knowing this, with the context defined by ECB Governing Council member Klaas Knot, who has previously said that higher yields are welcomed because “what the market is actually doing is pricing that optimism” about a recovery in the second half of 2021, if higher inflation leads to higher yields, the ECB won’t be inclined to do much whatsoever.
EUROPEAN CENTRAL BANK INTEREST RATE EXPECTATIONS (June 1, 2021) (TABLE 2)
It appears that rates markets feel similar, insofar as the ECB won’t overreact to recent inflation data as a sign that they need to add to or withdraw stimulus in the near-term. According to Eurozone overnight index swaps, the ECB won’t be changing rates anytime soon. In mid-January, there was a 54% chance of a 10-bps rate cut by December 2021; that probability now stands at 0%. Through April 2022, there is only an 11% chance of a 10-bps rate cut.
IG Client Sentiment Index: EUR/USD Rate Forecast (June 1, 2021) (Chart 2)
EUR/USD: Retail trader data shows 35.19% of traders are net-long with the ratio of traders short to long at 1.84 to 1. The number of traders net-long is 0.25% lower than yesterday and 8.70% higher from last week, while the number of traders net-short is 6.97% higher than yesterday and 5.85% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EUR/USD prices may continue to rise.
Positioning is more net-short than yesterday but less net-short from last week. The combination of current sentiment and recent changes gives us a further mixed EUR/USD trading bias.
— Written by Christopher Vecchio, CFA, Senior Currency Strategist
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