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ECB expected to hold interest rates

The European Central Bank (ECB) is universally expected to hold interest rates on Thursday. “See you after summer” was the closing remark from ECB president Christine Lagarde in June and since then there has been no material change in either data or ECB speaker sentiment. To my mind, Thursday’s meeting is more of a placeholder before an additional 0.25% of easing in September.

Inflation has progressed broadly in line the with the ECB’s expectations: it fell to 2.5% in June and is expected to drop further in Q3 thanks to supportive statistical calculations. In September we’ll also get a new set of forecasts for the “data dependent” central bank which to my view, makes a cut more likely in September.

Sterling set to benefit from relative yields and political stability

Perceptions of relative political stability, attractive UK assets and monetary policy divergence have supported sterling. But the next key test comes from Wednesday’s UK inflation data. Again, service sector inflation will be the market’s focus. Continued stickiness is likely to see August rate cut expectations reduced, with November the next likely date for the first interest rate cut from the Bank of England (BoE). A delayed loosening of monetary policy looks set to benefit sterling.

NatWest’s UK Economics team expects headline Consumer Price Inflation (CPI) to fall to 1.9% (year on year) in June from 2% in May. CPI services inflation is forecast to ease slightly to 5.6% from 5.7% – some progress but still above the BoE’s forecast in June (5.1%). Taken with hawkish comments from BoE chief Economist Huw Pill, the realisation of this forecast is unlikely to convince markets of an August interest rate cut. 

US inflation moving in the right direction

The assassination attempt on former US president Donald Trump at the weekend has nudged markets to favour him as an election winner, bringing some stability to the US dollar. But the inflation outlook is likely to be the key driver over the medium term.

To my mind, last week’s US CPI data is likely to have given both Jerome Powell the “more good data” and the Fed “greater confidence” that inflation is falling sustainably to the central bank’s target. As a result, markets quickly anticipated an earlier start and greater scale of interest rate cuts by the Fed this year and next. While our US Economists’ view remains for the first cut to come in December, rather than September, the progress on CPI does put a September rate cut firmly on the table. This brings negative headwinds for the USD, especially alongside softening labour market data. This week, I’ll be watching for any softening in tone from Fed speakers, as well as softening in US retail sales data on Tuesday.

For more NatWest insights into FX markets, listen to the Currency Exchange.

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