Overview of central bank supervision:
- The Bank of England and the European Central Bank are slow to fight against strong inflationary pressures.
- Rates markets are pricing in a 25 basis point rate hike by the BOE in May, while the ECB is expected to raise rates by 10 basis points in July.
- retail trader positioning suggests EUR/USD rates have a bearish bias, while GBP/USD rates have a mixed outlook.
Balancing growth and inflation
In this edition of Central Bank Watch, we will discuss the two major European central banks: the Bank of England and the European Central Bank. Both central banks continue to monitor the impact of Russia’s invasion of Ukraine on financial market liquidity (thanks to sanctions) and, in turn, have slowed their approach to deal with decades-long spikes in pressures. inflationary pressures in the euro area and the UK. Neither central bank seems to have much “teeth” behind their respective policies at present, leaving both the pound and the euro at a disadvantage.
For more information on central banks, please see the DailyFX central bank release schedule.
BOE Touring Ratings Remain Relatively Low
Among developed economies, the UK is perhaps the worst placed to deal with the twin threats of high inflation and low growth, in effect stagflation. The lack of aggressive forward guidance from the Bank of England exacerbates the problem, as markets have little confidence that the BOE will do what is needed to rein in the strong price pressures, which are at their highest level since 30 years. Of course, this perception comes downstream from comments made by the BOE’s chief economist, Huw Pill, in February, when he said he wanted to avoid “taking unusually large policy actions can validate a market narrative that Bank policy is either foot on the gas or foot on the brake.
Bank of England interest rate expectations (April 19, 2022) (Table 1)
As a result, rates markets don’t seem to buy into the idea that the BOE will act aggressively on inflation anytime soon – leaving the pound at a relative disadvantage when so many other major central banks have jumped in and signaled that they would rapidly raise rates in the coming months. UK Overnight Index Swaps (OIS) discount a 129% chance of a 25bps rate hike in May (a 100% chance of a 25bps hike and a chance 29% of a 50 basis point increase). Rates markets are still pricing in a 25 basis point rate hike at each meeting for the remainder of 2022; while seems aggressive, it’s actually a slower pace than where prices were back in February, before the Russian invasion of Ukraine.
IG Customer Confidence Index: GBP/USD Rate Forecast (April 19, 2022) (Chart 1)
GBP/USD: Retail trader data shows 75.25% of traders are net long with a ratio of long to short traders of 3.04 to 1. The number of net long traders is 7.23% higher than yesterday’s and 3.99% lower than last week, while the number of net-short traders is 0.92% lower than yesterday and 3.42% lower than this week last.
We generally take a contrarian view of crowd sentiment, and the fact that traders are net buyers suggests that GBP/USD prices may continue lower.
Positioning is longer than yesterday but shorter since last week. The combination of current sentiment and recent changes gives us another GBP/USD mixed trading bias.
The disconnect persists between the ECB and market ratings
As the European Central Bank pointed out last week, an end to stimulus efforts in Q3 22 remains the most likely course of action, putting the euro at a disadvantage in the near term: while other major central banks raise their rates in an attempt to curb price pressures, the ECB will not. Rates markets continue to price in July for the ECB’s first rate hike, but that should disappointgiven that the ECB does not want to raise rates before ending asset purchases.
EUROPEAN CENTRAL BANK INTEREST RATE EXPECTATIONS (April 19, 2022) (TABLE 2)
Eurozone OIS are pricing in a 10bps rate hike in July (115% chance), which seems too high. €STR, which replaced EONIA, is priced for 60 basis point hikes through the end of 2022 – again, way too high. If the ECB does not raise rates before ending asset purchases – what it has suggested is the course of action – the juxtaposition between the ECB and other major central banks will continue to grow, weighing on the economy. ‘euro.
IG Customer Confidence Index: EUR/USD Rate Forecast (April 19, 2022) (Chart 2)
EUR/USD: Retail trader data shows that 72.85% of traders are net long with a ratio of long to short traders of 2.68 to 1. The number of net long traders is 1.32% higher than yesterday and 0.55% lower than last week, while net-short trader counts are 0.09% lower than yesterday and 3.12% lower than this week last.
We generally take a contrarian view of crowd sentiment, and the fact that traders are net long suggests that EUR/USD prices may continue to decline.
Traders are sharper than yesterday and last week, and the combination of current sentiment and recent shifts gives us a stronger contrarian EUR/USD-bearish trading bias.
— Written by Christopher Vecchio, CFA, Senior Strategist