March Review

Last month, currency markets saw subdued activity, with GBP/USD trading within a narrow range of 1.2580 to 1.2880, while GBP/EUR held steady between 1.1630 and 1.1758. The low volatility among the three key global economies reflected the stagnant interest rates, which have remained 'paused' for as many as five consecutive meetings while central banks decide whether the battle against inflation is won.

However, the month did take an unexpected turn in Switzerland, with the Swiss National Bank (SNB) surprising markets by reducing its primary interest rate by 25 basis points to 1.50%. This move weakened the Swiss franc against the euro, and Swiss government bond yields plummeted while stocks on the Zurich stock exchange surged.

Analysts, largely anticipating a conservative stance from the SNB, were caught off guard by the rate cut. The decision came amidst easing Swiss inflation, which stood at 1.2% in February, comfortably within the SNB's target range of 0-2% for the ninth consecutive month.

Meanwhile, the Bank of Japan (BOJ) took a divergent path, raising its key interest rate from -0.1% to 0% to 0.1%. The move, prompted by rising wages and consumer prices, was the first rate hike from the central bank in 17 years and signals a departure from the negative interest rate policy implemented in 2016 to stimulate Japan's sluggish economy. There are now no countries with negative interest rates.

Towards the end of the month, the pound faced headwinds following a promising start to the year, experiencing losses against most G10 currencies. The drop in value followed some softer data releases, including the latest Consumer Price Index (CPI) inflation data, which came in 0.1% lower than anticipated and now sits at 3.4%. 

Although this is still above the Bank of England's 2% target, this figure represented a significant decrease from the previous month's 4%, signalling a potentially quicker-than-expected return to normality. 

As expected, the Bank of England voted to maintain interest rates at 5.25% in the monetary policy decision that followed the inflation data. However, Governor Andrew Bailey also suggested that the UK economy was moving towards the point where the Bank of England could start cutting rates.

As a result of these developments, the pound dipped to its lowest levels against the euro since January, with interbank rates touching 1.1599 before a market correction. Similarly, GBP/USD experienced a downward trend, falling from 1.28 to 1.2577.

Outside of economic data over the last month, recent polls conducted by Survation on behalf of Best for Britain suggest challenging times ahead for the Conservative Party, with projections indicating it could be heading towards its worst election outcome on record. The poll suggested the party could secure fewer than 100 seats, while Labour could dominate with 468 seats, resulting in a substantial 286-seat majority for Sir Keir Starmer.

The survey was based on a sample of 15,000 individuals and showed Labour could hold as much as a 45% vote share, leading the Conservatives by 19 points. The results also indicated that Prime Minister Rishi Sunak risks losing his own constituency, the Richmond & Northallerton seat in North Yorkshire, to Labour, as he currently only holds a narrow lead of less than 2.5%.

USA

The US dollar strengthened towards the end of the month, leading to a decline in EUR/USD from its peak at 1.0940 to 1.08. 

The Federal Reserve kept interest rates unchanged at 5.5% following its monetary policy meeting, maintaining one of the highest levels compared to other developed nations. The central bank also released its interest rate forecasts for the upcoming years, projecting a bullish outlook. The dot plot indicates it expects interest rates to reach 4.6% by the end of 2024, 3.9% by the end of 2025, and 3.1% by the end of 2026.

Last month also saw President Joe Biden enjoy gains in six of seven key swing states, marking his strongest position yet in a recent Bloomberg News and Morning Consult poll. Following a consistent lead by Trump across the last five months, Biden's advancement follows a State of the Union address that bolstered Democratic support and seemed to ease concerns about his age. 

Notably, Biden now leads Trump by one point in Wisconsin (up from a four-point deficit in February), and the candidates are tied in Pennsylvania (where Trump previously held a six-point lead) and Michigan. While it's uncertain if this shift is temporary or indicative of a lasting change, Biden still trails the presumptive Republican nominee in four crucial states. However, victories in these "Blue Wall" northern battlegrounds could significantly boost Biden's prospects for a second term.

April Outlook

Only the ECB will be meeting in April among the major central banks; however, this month's critical data may give us a better or changing view of the interest rate path. The key factors will be inflation and economic growth. These will feed into policymakers' decisions going into the second half of the year.

Inflation

The Fed's Chair Jerome Powell reacted positively to the US's latest inflation report, indicating that it aligned with the desired trajectory towards the central bank's 2% target. During a Q&A session at a San Francisco Federal Reserve conference, Powell noted that although recent data doesn't match some favourable readings from the previous year, it still indicates progress.

Powell specifically referred to newly released data showing a modest slowdown in the Personal Consumption Expenditures index, the Fed's preferred measure of inflation.

Markets will now be looking ahead to the next CPI inflation data release on 10th April for further insights into the inflation trend.

There are also signs of relief in the UK as shop prices hit a two-year low, according to data released on 2nd April. Retailers appeared to have slashed prices on Easter treats, clothing, and electrical goods, to attract consumers after a slowdown in spending.

The data, released by the British Retail Consortium (BRC) and NielsenIQ, showed prices in March increasing by just 1.3% annually, a significant drop from February's 2.5% and marking the slowest pace since December 2021. Non-food inflation also plummeted to 0.2% from 1.3% the previous month, while food inflation moderated to 3.7% from 5%. The next CPI inflation data release in the UK is scheduled for 17th April.

According to Eurostat, Eurozone CPI inflation data presents a mixed picture across the bloc, hovering around 2.8% year-on-year. April’s inflation figures were released on 3rd April, coming in below economists’ forecasts and showing a month on month decline to 2.4% in March, continuing the downward trend from the previous month's 2.6%.

Growth

While inflation generally shows a downward trend – although some are faster than others – across the UK, US, and EU, growth data paints a more divergent picture.

Official statistics released at the end of March confirmed the UK's technical recession in the second half of last year. The Office for National Statistics reported a 0.3% quarter-on-quarter GDP contraction between October and December 2023, consistent with initial estimates. 

This confirmation further challenges Prime Minister Rishi Sunak's economic growth agenda, overshadowing his efforts to stimulate the economy. However, the start of 2024 seems to be more positive, with a 0.2% monthly increase in GDP in January, driven by a surge in high street and online spending. 

While Europe has managed to avoid a recession, GDP growth stagnated at 0.0% for Q4 2023, with Germany and Ireland dragging down the figures.

In contrast, US GDP growth remains strong, at 3.4% in the fourth quarter of 2023. Revised figures highlight upward adjustments in both consumer spending and non-residential fixed investment, surpassing initial estimates and underscoring the resilience of the US economy despite high-interest rates.

Interest rates

Interest rates are poised to begin a downward trend, with all three central banks having now indicated their rate hiking cycle has finished, although markets anticipate that any cuts won't come before June.

The ECB is expected to lead the interest rate cuts, with speculation pointing towards a reduction in their June meeting. With inflation relatively stable in the EU and several major Eurozone economies grappling with sluggish growth, the conditions for an interest rate reduction are looking more likely.

Given its persistently higher inflation than its counterparts, the UK appears less inclined to cut interest rates too quickly. As a result, a rate cut is anticipated in August or September, with the possibility of further delay if inflation remains elevated.

The Federal Reserve is expected to start rate cuts somewhere in the middle, with the first cut coming in June or July, providing inflation levels don't continue to exceed the target threshold.

How could this impact the FX market?

Across the FX markets, where interest rate expectations are currently the most significant driver, the outlined forecasts provide a clear trajectory that is likely already factored into prevailing exchange rates. However, we could see substantial market shifts should any unexpected events occur. 

These could be:

• Stable or elevated inflation:Currencies could strengthen if inflation remains steady or even rises compared to previous months. This implies that interest rates may remain higher for an extended period, attracting foreign investment.
• A sharp decline in GDP growth:A sudden and substantial drop in GDP growth could weaken the associated currency. This signals economic weakness and could prompt earlier interest rate cuts to stimulate growth, further dampening investor confidence.
• Delayed interest rate cuts: If the ECB, Fed, or BOE signal or decide to postpone interest rate cuts beyond the projected timeframes, it could benefit the respective currency in the short term. This delay might suggest a more resilient economy than previously thought, bolstering investor sentiment.

Data sourced from Bloomberg

This commentary does not constitute financial advice and all quoted rates are sourced from Bloomberg.