Please note there will be no Week Ahead on the weeks of 26th Dec and 1st Jan. Merry Christmas, Happy holidays, and a Happy New Year. 

As the year comes to a close, the situation in the economy is creating a degree of difference as far as what the Bank of England (BoE) Monetary Policy Committee (MPC) members believe is the right course of action on interest rates. Last week’s decision from the BoE to raise the Bank rate by 50 basis points to 3.5% was only supported by six of the nine strong MPC, with Catherine Mann voting for a 75 basis point hike, but members Dr Swati Dhingra and Silvana Tenreyro wanting to leave interest rates at 3%. The BoE claimed that the changes to fiscal policy in the Chancellor’s Budget would raise GDP by 0.4 percentage points in the next year, but cut GDP by 0.5% in three-years’ time. Overall, the BoE saw limited changes to the inflation outlook versus November, despite the recent unexpectedly large drop in headline Consumer Price Index seen in the latest release.

The BoE will have further headaches to come. The end of the week saw the November retail sales report indicate that the period of heavy discounting had been something of a bust as far as most retailers were concerned, with the squeeze on household disposable incomes seeing consumers exerting restraint on spending. There was a fear that the BoE might hike by 75 basis points, which would have been viewed as front loading the tightening, rather than a higher peak. In the aftermath of the BoE decision, the GBP fell, as markets revised assessments of the peak in UK interest rates following the dissent from two members.

The macro picture is further complicated by the downside risks to the UK property market. One of the brighter spots of the UK’s recovery in the period post the initial COVID downturn, the UK housing market has experienced a sharp reversal in the past few months, and is expected to be in a full-blown recession over the course of 2023.

For this week, there are no important data or survey releases due. The risks to GBP are on either side, and made more pronounced by a reduction in liquidity as we rapidly approach the holidays and the end of the year. I still view the risks to the downside for the GBP, with the economic risks more pronounced than in other major economies, in my opinion.

The last European Central Bank (ECB)Governing Council meeting of the year saw interest rates rise by 50 basis points, but also saw the President, Christine Lagarde, suggest that there was more to do in terms of tightening, perhaps beyond what is priced for by markets for the coming few meetings. Whilst there was a recognition that the outlook for activity had worsened, there were still greater fears over the effects of supply-side and geopolitical influences on inflation and how that would impact on wage settlements into 2023. 

The prospect of Euroland interest rates being higher in the early stages of 2023 than had been predicted prompted some further EUR strength, with a rise in EURUSD briefly above $1.07 and GBPEUR dropping to exactly €1.14. The currency has enjoyed a healthy recovery after plunging to multi decade lows against the USD as recently as September, but the help from domestic economic data and surveys might be limited, or non-existent, into the early part of 2023, beyond higher interest rates.

I suspect that, if the economic data worsens in Q1, the ECB’s appetite to tighten aggressively from here will weaken, but for now it looks likely the February meeting will deliver a 50 basis point hike unless there is some currently unknown factor that undermines the global demand or has a negative effect directly on the Euroland economy.

The Federal Reserve also hiked by 50 basis points last week, with the decision a unanimous one amongst the FOMC (Federal Open Market Committee). The Chair, Jerome Powell, re-highlighted that the Fed were closely watching the labour market for signs of weakness, with the wage inflation numbers being the key element to the decision making of the Committee, according to its Chair. However, labour markets have traditionally been a lagging indicator of economic performance, which possibly invites the risk of over-tightening policy as other measures of activity worsen ahead of the labour market.

The Federal Reserve suggested that it would raise interest rates further, at least according to the dot plots (the survey of all members’ views of where interest rates will be at the end of 2023, 2024 and in the longer term). The peak in interest rates was seen between 5.25-5.5% for the upper bound of the targeted Fed Funds rate, something that is at odds with where the markets think rates will peak (below 5%).

The data and surveys last week were mixed, but generally the surveys were negative regarding activity, and point to the accumulation of interest rate tightening worsening the outlook for manufacturing and services. This week’s releases are more limited, but there will be interest in the consumer confidence readings from the Conference Board and University of Michigan for December. There should also be interest in the housing market data and the November leading index figures.

As for the US dollar, it made some headway at the end of last week, recovering a little of its lost ground versus other majors, but there may be limited appetite to maintain the momentum of a renewed USD rally with liquidity fading into the holiday season, in my view.

Last week saw the central banks of the Philippines, Switzerland, Norway, Mexico and Colombia accompany the decision from the big three major central banks. The central bank of Philippines kicked things off with a 50 basis point hike to 5.5%, which followed hot on the heels of the Fed’s decision, so was hardly a surprise. The Swiss National Bank also hiked interest rates by 50 basis points, and suggested its fight against inflation has not been won yet, so there are likely to be more hikes to come. The Norges Bank only hiked by 25 basis points, to 2.75%, and signalled that rates are approaching a peak, but may not be quite there yet. As for the central banks of Mexico and Colombia, Banxico hiked by 50 basis points whilst the Colombian central bank hiked a full percentage point, but surely both are also now close to where the peak will be for interest rates in each of these economies. Generally the pace of hikes has slowed somewhat, and central banks in emerging markets in particular will have to be mindful of the effects of the accumulated tightening on activity.

For this week there are fewer central bank meetings to take note of, but there will be interest in the People’s Bank of China (PBoC), Bank of Japan, central bank of Hungary and Czech central bank decisions. The PBoC have been adjusting reserve requirement ratios rather than the interest rates themselves, but there remains a risk of lower interest rates as well, if by only 10 basis points or so, over the next few meetings, whilst the remainder of the central bank meetings should see policy left unchanged, as fears of recession grow in Eastern Europe and the Bank of Japan continues to try and foster a post-COVID recovery. The stage is set for an intriguing 2023 as far as all of these central banks are concerned, with the economic risks perhaps prompting some aggressive policy action from all areas of the globe, in my view.