Yellen admission of declining inflation in the US takes USD down
Central banks were once again at the front and centre of movements in currency yesterday with most of the action taking place courtesy of the Federal Reserve and Bank of Canada; one talking up the possibility of another rate rise whilst the latter plumped for that rarest of creatures, a hawkish hike full of optimism.
Janet Yellen’s testimony to the Senate did not see her language shift much from what she said in the minutes of the June Federal Reserve meeting but where there was a shift was enough to take the USD lower on the session. Needless to say they were comments on inflation that took the dollar lower with Yellen stating that ‘inflation was running below goal, and has declined recently’ as well as calling the ‘inflation response to the economy the key uncertainty’. All in all this confirms our view that the 2nd half of the year may see some movement on rates higher and similarly a beginning to the reduction of the Fed’s balance sheet but that there is enough inflation concerns to give pause until later in the year.
New normals in growth and rates
One of the most telling comments was that interest rates would not have to move much higher from current levels to reach what the Fed believes to be the lower bound of the ‘neutral rate’ – a rate which is not seen as stimulatory or contractionary on the economy. This is important because it may mean that another few rate rises is enough for the Fed and as much as we will have to get to grips with ‘new normals’ in growth levels we will have to do so in interest rates as well.
USD initially fell across the board before recovering against the euro and sterling and once again falling through the Asian session. The near-term outlook does not look strong for the USD. However, a run of data hinting at inflationary pressures would see a rebound of some speed. US producer prices are due this afternoon.
Canada raises rates
Similarly in Canada, USDCAD fell by 2.3% on the session as the Bank of Canada delivered a rate rise and happy days are here again. The policy decision and statement was bullish and noted higher growth and while inflation remains below target a belief that this is ‘transitory’. We will wait and see but much like in the UK the consumer credit dynamics are stretched and those in the UK who are searching for a Bank of England rate hike may be minded to keep an eye on what pressure the average Canadian consumer is put under in the coming months.
We see little pressure elsewhere for hikes in rates in the G10.
UK basic pay rises but real wage silver bullet remains elusive
Here in the UK and despite an increase in basic wages to 2%, pay settlements including bonuses fell to 1.8% in May and sit 1.1% below the latest CPI release.
Real wage gains are the silver bullet for the concerns that swamp the UK economy at the moment; they come from optimistic employers happy with business conditions (which the UK do not have), they allow consumers to re-balance spending figures from credit uptake (which we urgently need) and promote growth in generalised output with a central bank more comfortable to normalise monetary policy (which is an argument that desperately needs clarity but yet there is little to be found).
The labour market is solid at the moment but it has been solid for a long time and has not been enough to generate reliable and meaningful wage growth. Yesterday’s wage data may increase some expectations of a Bank of England rate hike in the coming months but we consider these beliefs to be incorrect given an expected fall in inflation by the end of the year as the post-EU referendum currency effect falls out of the numbers.