Persistent Bearish Momentum Defines GBP/USD Currency Pair Movement

The Bank of Canada heads towards its second policy meeting of the year with some good news on the inflation front. The consumer price index eased to 2.9% y/y in January from 3.4%, falling below 3.0% for the first time since June 2023 when the disinflation process came to a pause.

Crucially for policymakers, all three of the Bank of Canada's core measures of inflation tumbled in January to levels last seen in late 2021. Whilst it's too early to know whether this will be another temporary dip, the likelihood that inflation will soon hit 2% has gone up, raising the prospect of a rate cut sooner rather than later.

Overall rate cut expectations have been pared back since the start of the year, in line with the repricing for the Fed and other major central banks. Nevertheless, a 25-basis-point rate cut is now almost fully priced in for June.

The Bank of Canada had predicted in January that inflation would hold around 3.0% in the first half of 2024 so the lower-than-expected CPI print could prompt officials to anticipate a faster return to the 2% target.

However, policymakers will likely want to see more evidence of inflation heading towards 2% in a sustainable manner and more data won't become available until the Bank of Canada's April meeting when coincidentally a new set of projections are also due to be published. Hence, a major policy shift is unlikely at the March meeting.

Yet, for the Canadian dollar, which has been on the backfoot versus the greenback all year, even a slight dovish lean by tweaking the language in the statement could worsen the bearish pressure.

Dollar/loonie is currently trading near two-month highs as the pair eyes the 1.3600 level. A dovish hold on Wednesday could see the pair test the 61.8% Fibonacci retracement level of the November-December downleg before aiming for the 78.6% Fibonacci of 1.3745.

However, if the BoC maintains a cautious stance amid concerns about the housing market heating up again, dollar/loonie could pull back towards its ascending trendline that is being tracked by the 20-day moving average. A bigger correction would bring the 50-day moving average into scope at 1.3439.

Canada's property slump appears to have bottomed and there are some indications that house prices have started to rise again. A recovery in the housing market at a time when shelter costs are already very high due to rising rental prices and higher mortgage costs could complicate things for the Bank of Canada.

Shelter inflation is currently the biggest upward contributor to prices in Canada and cutting rates risks exacerbating the problem.

The rebound in housing comes amid a broader bounce back in economic activity. Canada's economy returned to growth in the final quarter of 2024 following a contraction in GDP in Q3. The jobs market also appears to be on the mend with the unemployment ticking lower in January.

The next employment report is released on Friday (13:30 GMT) and investors will be watching for more signs that jobs growth is picking up. With wage growth running above 5.0%, a hot labour market would be another obstacle for the Bank of Canada to cut rates anytime soon.

European shares experienced a momentary pause near record highs following an impressive six-week rally, prompting investors to seek confirmation on central banks' commitment to future interest rate cuts. The pan-European Stoxx 600 registered a modest 0.1% gain, with particular strength seen in the tech shares subindex, reflecting the positive momentum from Wall Street's previous session. Notably, Nasdaq 100 futures hinted at the possibility of continued advancements, especially for major tech players such as Nvidia Corp.

While this pause in European shares occurred, the S&P 500 index in the United States has been on an extraordinary run, posting gains in 16 out of the last 18 weeks—an achievement not observed since 1971. A key driver of this sustained rally was reinforced by promising U.S. economic data, reinforcing expectations that the Federal Reserve might engage in rate cuts later in the year. The ongoing earnings season added fuel to the fire, revealing companies with an average growth rate of 8%.

Jefferies strategist Mohit Kumar highlighted the positive sentiment among investors, stating, "Whether it’s the economic outlook or the central bank 'put' being back on the table, investors are very positive on risky assets." Despite the market adjusting its expectations for Fed policy-easing to July, Kumar maintains a projection of 75-100 basis points worth of rate cuts throughout the year.

As the market awaits crucial signals, Federal Reserve Chair Jerome Powell's upcoming congressional testimony, the European Central Bank's policy meeting, and a slew of economic data, including U.S. monthly payroll figures, stand out as potential drivers of market sentiment.

In premarket U.S. trading, chipmakers sustained their upward trajectory, with Western Digital Corp., Micron Technology Inc., and Nvidia all displaying positive momentum. However, Tesla Inc. experienced a minor dip. Meanwhile, in Europe, Delivery Hero SE saw an uptick following the announcement of a financing transaction to amend and extend its financing facilities.

Looking towards Asia, Taiwan Semiconductor Manufacturing Co., the world's leading chipmaker, reached its highest-ever level, underscoring the global nature of the market dynamics.

As the financial markets navigate a landscape influenced by central bank policies, economic indicators, and corporate performance, investors are keenly observing the delicate balance between these factors. The anticipation of future rate cuts, technological advancements, and strategic financing decisions collectively shapes the evolving narrative of the financial markets, highlighting their dynamic and interconnected nature.

The Eurozone economy faced a particularly challenging period during the second half of 2023, with the region only narrowly avoiding a technical recession. Given the challenging growth environment, the European Central Bank (ECB) ended its tightening cycle with a final 25 bps rate hike in September last year and has, since early 2024, indicated the next move is likely to be a rate cut. The outlook for ECB monetary easing has been fluid, with expectations for an initial ECB rate cut at times fluctuating between April and June. That said, firmer Eurozone PMI surveys, a still-gradual disinflation process, and the weight of ECB policy rhetoric have seen expected rate cut timing shift more solidly towards June. In that context, we now also expect the ECB will begin its easing cycle with a 25 bps Deposit rate cut to 3.75% at its June monetary policy announcement.

One of the most significant data releases since the European Central Bank's (ECB) most recent policy announcement was the Eurozone PMI surveys for February. Of particular note, the February service sector PMI rose more than expected to 50.0, from 48.4 in January. That saw the services PMI exit contraction territory for the first time since July of last year. Service sector sentiment for the region's largest economies was also favorable, as Germany's services PMI rose to 48.2 and France's services PMI rose to 48.0. The news from the Eurozone manufacturing PMI was not as upbeat, as that index unexpectedly eased to 46.5 in February from 46.6 in January, driven by weakness in German manufacturing. Still, with the service sector a much more sizable portion of the overall economy, the Eurozone composite PMI also rose to 48.9 in February, from 47.9 the prior month. Although not as significant as these headline figures, the details of the February PMI survey also hinted at lingering inflation pressures. The report noted that growth of average input costs across producers of goods and providers of services accelerated for a second successive month to reach the highest level since last May. The report also said that selling price inflation likewise accelerated, up for a fourth month running in February to also hit the highest level since last May.

Other confidence surveys since the ECB's latest announcement are more mixed. At a national level, Germany's February IFO business confidence index rose to 85.5, but French business confidence and Italian economic sentiment both fell in February. Meanwhile, the European Commission's Economic Sentiment Indicator for the Eurozone also fell to 95.4 in February, but that same survey showed the Employment Expectations Indicator edging up to 102.5 in February, a level historically consistent with positive jobs growth. That suggests steady Eurozone labor market trends can continue. In recent weeks, labor market indicators have shown continued employment growth in Q4 of 0.3% quarter-over-quarter and 1.3% year-over-year, and a January unemployment rate that fell to 6.4%, a record low. Taken together, the firming in the PMI indices and mixed readings from other sentiment surveys, along with steady labor market trends, offer early—albeit tentative—signs the Eurozone economy is stabilizing. At the margin, we think tentative economic stability has reduced the urgency for ECB monetary easing, and is a contributing factor to expectations for an initial ECB rate cut getting pushed back to mid-year.

The other key pieces of Eurozone economic news since the ECB's latest policy announcement were inflation data for January and February. Those figures revealed some further progress on the disinflation front, albeit at a gradual pace. For the February CPI, headline inflation slowed to 2.6% year-over-year and core inflation slowed to 3.1% year-over-year. Service sector inflation remained somewhat sticky, easing only slightly to 3.9%. To be sure, the deceleration in annual inflation was flattered by base effects related to the large price increases that were seen in early 2023. Taking a closer and more granular look and price trends over the past six months, we note that the CPI excluding food and energy—which is close to but not identical to the official core CPI measure—has advanced at a 2.3% annualized pace. Thus even over this shorter time period, underlying inflation trends have moved closer to, but not yet converged, to the ECB's 2% inflation target. And likely of concern to ECB policymakers, services inflation has persisted over the past six months, rising at a 3.4% annualized pace during that period.

Another reservation regarding the inflation outlook, and one cited by several ECB policymakers, is the still-elevated pace of wage growth. The most up-to-date wage figures available on a Eurozone-wide basis is the ECB's indicator of negotiated wages. The negotiated wage index decelerated slightly to 4.5% year-over-year in Q4 from 4.7% in Q3 but, at least for now, suggests wage growth is at a level that is probably still too high to achieve the 2% inflation target on a sustained basis. The fact that the unemployment rate is at a record low perhaps reinforces concerns that wage growth may decelerate only gradually. It is against this backdrop, and despite the improving inflation trends of the past several months, that ECB policymakers have been wary of moving too aggressively in lowering interest rates, and have indicated an increasingly clear preference to see wage trends from early 2024 before making a decision to adjust interest rates. Those wage data for early 2024 will only be available in time for the ECB's June monetary policy announcement, and not for the ECB's April monetary policy announcement.

Chief among comments from policymakers have been those of ECB President Lagarde. Among her more recent comments, she said the ECB must be convinced that disinflation is sustainable and that Q1 wage data will be important for the ECB's assessment. Some other policymakers (Nagel, Holzmann, Schnabel) have cautioned against early rate cuts, while others have indicated a desire to see more wage data or even cited June as more likely timing for initial ECB easing. In the wake of these comments, market participants are now pricing in just 6 bps of rate cuts for the April meeting, and 24 bps of rate cuts for the June meeting.

Given current market pricing, it would likely take a proactive effort from ECB policymakers to accelerate the market's easing expectations and to allow for an April rate cut to become a more realistic possibility. That proactive guidance from ECB policymakers is something we view as a low probability outcome. Indeed, for those hoping for dovish elements from the ECB monetary policy announcement on 7 March, at best we expect the ECB to repeat it is "not there yet" on inflation, to perhaps caution against premature monetary easing, and to repeat that its preference is to see more wage data before adjusting its policy interest rate. At worst, we would not completely rule out more aggressive guidance in which the ECB takes the possibility of an April rate hike off the table. The other key element of the ECB's March monetary policy announcement to watch will be the central bank's updated economic projections. In the absence of a significant downward revision to its inflation forecast (in December, the ECB projected CPI inflation ex food and energy at 2.3% in 2025 and 2.1% in 2026), there would also be little reason for market participants to pull forward their expected rate cut timing. Since we view dovish policy guidance and/or a sharp downward revision to inflation forecasts as unlikely at the ECB's March announcement, and at the risk of adjusting our own forecasts with 'perfectly imperfect' timing, we now view an initial 25 bps Deposit Rate cut to 3.75% at the ECB June's monetary policy announcement as the most likely outcome.

Beyond the initial June move, we expect the ECB will keep lowering interest rates in steady 25 bps rate cut increments at the following meetings. We expect Eurozone economic growth to improve, but remain moderate overall. Meanwhile, we expect wage growth in particular, and price inflation to a lesser extent, to decelerate further as the year progresses. Should those economic trends transpire, we forecast the ECB will follow up with 25 bps rate cuts at the July, September, October and December meetings, which would see the Deposit Rate end 2024 at 2.75%. As the ECB's policy rate moves somewhat closer to a more neutral level and economic activity firms further in 2025, we expect a step down in the pace of ECB rate cuts to once per quarter next year. We forecast 25 bps Deposit Rate cuts in March, June and September 2025, which would see the ECB's policy rate reach a terminal level of 2.00% by late next year.

In the United States, all eyes are set on the January labor report, which is anticipated to provide crucial insights into the health of the nation's economy. Projections suggest a moderation in non-farm payrolls growth to 188K, marking a significant decline from the robust 353K jobs added in January. Additionally, market participants await updates on the unemployment rate, expected to remain steady at 3.7%, and wage growth, which is forecasted to cool to 0.2% from the previous period's 0.6%. Alongside the labor report, investors will closely scrutinize the Federal Reserve's messaging, particularly Fed Chair Powell's Semiannual Monetary Policy Reports to Congress. The central bank's stance on interest rates and inflation will be of paramount importance in guiding market expectations and asset allocation strategies.

Furthermore, the release of the ISM Services PMI for February is poised to offer insights into the performance of the service sector, with expectations of marginal growth following January's four-month high. JOLTs job openings data will also be closely monitored, with forecasts suggesting a decline to 8.9 million in January after two consecutive months of increases. Other notable data releases include the ADP employment change, factory orders, foreign trade figures, and the RCM/TIPP Economic Optimism Index, all of which will contribute to shaping the narrative surrounding the US economic outlook.

In Canada, market participants await the Bank of Canada's interest rate decision, widely expected to maintain the status quo amid ongoing risks to the inflation outlook. The central bank is likely to adopt a cautious approach, given the prevailing uncertainties surrounding global economic conditions and domestic inflationary pressures. Attention will also be on Canada's employment figures, trade balance data, and the Ivey PMI, providing valuable insights into the country's economic performance and the trajectory of monetary policy.

In neighboring Mexico and Brazil, key economic indicators such as inflation, consumer confidence, industrial output, and foreign trade will be closely watched for signals of economic resilience amidst global headwinds and domestic challenges.

In Europe, the focus turns to the European Central Bank's monetary policy decision, with expectations leaning towards a continuation of the current accommodative stance. The recent uptick in inflation, surpassing expectations, is likely to reinforce the central bank's cautious approach towards normalizing monetary policy. Economic indicators across the Eurozone, including retail sales, industrial production, and service sector performance, will provide valuable insights into the region's economic trajectory. Notable highlights include Germany's factory orders and industrial production, France's industrial output, Italy's service sector expansion, and Spain's unemployment data.

Additionally, market participants will closely monitor the United Kingdom's pre-election budget announcement, expected to feature measures aimed at addressing the country's substantial debt burden. Economic releases such as the BRC retail sales monitor, Halifax house prices, and final S&P PMI figures will offer insights into the UK's economic health and policy direction.

In Asia, China's National People’s Congress takes center stage, with investors eagerly anticipating announcements of fresh stimulus measures to support economic growth and consumer demand. Regulatory developments aimed at stabilizing the country's equity market will also be closely watched for their potential impact on investor sentiment. Key economic data releases include China's trade balance figures, which are expected to show a slight uptick in both export and import growth, as well as the Caixin Services PMI, providing insights into the performance of the service sector.

Elsewhere in the region, Japan is set to release its January current account data, while South Korea will unveil inflation figures and PMI data for February. In Southeast Asia, the Philippines will provide updates on inflation and unemployment, while Malaysia's policy rate decision will be closely scrutinized in light of ongoing currency weakness.

In Australia, market participants await the fourth-quarter GDP release, with consensus estimates suggesting steady growth momentum. The performance of the housing market, as indicated by data on home credit and building permits for January, will offer insights into the resilience of domestic consumption and investment trends.