Central bankers wrap: Inflation concerns the Fed, as the ECB 'intervenes' in euro

The ECB: the ECB shocked the markets on Thursday when it mentioned that ECB members are concerned about the “risk of the euro overshooting”. This sent the euro tumbling and led analysts to question whether or not this is the ECB equivalent of verbal intervention in the FX market. Earlier this week a Reuters report said that Draghi and co. won’t announce any new policy announcements (i.e. the end of its Asset Purchase Programme) at Jackson Hole. Today’s minutes suggest that the ECB won’t take any steps to normalise monetary policy unless some of the froth comes off the euro. After initially tanking on the immediate release of the minutes, the euro has made a bit of a comeback suggesting that the market is willing to test the ECB’s resolve to normalise monetary policy while at the same time keep a lid on euro strength. The message from these minutes are likely to enliven euro bulls, who may see recent weakness in the single currency as a chance to get in at a better level. We would look for a stronger euro in the lead up to the Jackson Hole conference.

The FOMC: There is a strong precedent for the head of the Federal Reserve to announce policy changes at Jackson Hole compared with the other major central banks. However, after the minutes of the July meeting it looks like the Fed has pressed pause on its rate hiking cycle, and although it plans to reduce the size of its balance sheet it will only do so at a snail’s pace, which limits the impetus to buy the dollar on the back of Fed policy normalisation. This could be Janet Yellen’s final Jackson Hole conference, her term expires in 2018, and there is no guarantee that she will be given another term by President Trump. This could mean that her final appearance is either meaningless – she won’t be setting policy soon anyway – or she could say explicitly what the Fed should do next and what the government is failing to do to help the economy, and throw caution to the wind as she won’t be governor for that much longer. If she chooses the latter, we still think that the market reaction will be quite small. There is now a less than 50% chance of a rate hike in December, and we think it is too early for the Fed to commit to another rate hike that far out, especially with inflation pressure so low. We also believe that the Fed’s policy tool of choice going forward will be the balance sheet, however, if that happens we believe that the market effect will be smaller, and may not be enough to ignite a dollar recovery in the long term. Thus, although we see the dollar clawing back some gains in the next week or so, we don’t think that it will make a sustained recovery in the long term especially not against the EUR and AUD.

The Bank of England: Although the BOE governor said during the presentation of the August Inflation Report that the Bank will hike rates, we don’t think that it will do so for some time. A rate hike is roughly priced in for the end of 2018, but that is so far out it has virtually no bearing on the FX market. The pound is likely to meander around multi-year lows of $1.25 vs. the USD and EUR/GBP may reach parity, both of which would be good news for the FTSE 100. Brexit uncertainty, a weak economic outlook, falling inflation and negative real wage growth tie the BOE’s hands for the long term and also could weigh on the pound as we move into the autumn.

The Reserve Bank of Australia: Minutes from the RBA this week and more talk about currency strength, were the order of the day for the Aussie. The RBA said it would be willing to intervene to weaken the Aussie if it thinks it is appropriate, however, it had no plans to change monetary policy. This was like a red rag for Aussie bulls, and in the aftermath of Wednesday’s minutes AUD/USD has rallied nearly 2%. The lesson here is: don’t start on intervention talk if you don’t plan on changing monetary policy. The RBA may find out, along with the ECB, that you can’t always get what you want, but empty threats against a currency usually don’t work out as planned, as the RBA is starting to realise. The Aussie is currently the strongest currency in the G10 this week.

The Riksbank: The pressure is on the Swedish central bank to hike rates, they currently stand at -0.5%, however, growth is strong and CPI is rising fast, on an annual rate it jumped from 1.7% to 2.2% in July. The Riksbank is known for its cautious approach and it is not expected to hike rates when it next meets on 7th September, the same day as the ECB. However, with price pressure building, we expect that it will have to start hiking soon, and the bank may confirm as much at next month’s meeting. This should keep upwards pressure on the SEK especially versus the JPY and GBP. We also think that USD/SEK could fall further if Janet Yellen strikes a dovish tone at next week’s Jackson Hole conference.