Central Banks face dilemma

Risk sentiment turned more positive last week, helping sterling and the euro recover some of the ground they had surrendered recently to the dollar. Sterling was one of the primary beneficiaries and rallied through the week to end over a cent higher. Sterling also appreciated against the euro and, in doing so, established a new high for the year. Several observers attributed the dollar's weakness to profit-taking after several weeks of a bull run by the greenback, and we will watch for confirmation of this in the days ahead.

Over the weekend, the Governor Bank of England, Andrew Bailey, indicated that he was ready to raise rates to counter the threat of inflation. With this in mind, investors in sterling look set to continue to ignore any worries about Brexit or stagflation and concentrate on the prospect of an increase in Base Rate rate, possibly as soon as the Old Lady's next meeting on November 4th.

A quiet week on the data docket is in store, with mainly second-tier data being released apart from the UK, where a key update on inflation is scheduled for Wednesday morning. The effect of rising energy prices and a scarcity of some goods is starting to feed through into inflation but may not be fully reflected in this data. As rates look set to rise, the currencies of the first movers, such as the Bank of England and the Federal Reserve, will continue to benefit from demand.

The Central Banks all face a dilemma, tighten too early, and they may dent the nascent economic recoveries, and if they are too slow, inflation takes hold; it is a tricky balancing act. Investors will also be keeping an eye on supply chain problems caused by shipping disruption and ongoing issues over Brexit.

GBP

The European Commission's seemingly conciliatory moves over Northern Ireland were warmly received by the market, helping sterling to new highs against the single currency. As always, the devil will be in the detail, and it is to be expected that the UK Government will push back on the proposals. As a consequence, the short term direction of the pound may be set by the rhetoric of politicians on both sides of the English and Irish Channel as await Wednesday's data. With thoughts focused on an earlier than anticipated interest rate hike by the Bank of England, this week's inflation figures, released on Wednesday, will be pored over for signs that recent price rises are continuing.

September's Consumer Price Index is the most important of the series, which also sees the Retail Price Index and the Producer Price Index reported. Analysts expect a CPI figure of 3.2%, which could well be the lowest figure we see for some time, with most forecasters predicting a rise to 4.5% over the coming winter months. Also released are September's Retail Sales and a first (flash) estimate of October's Purchasing Managers Indexes.

Unusually Bank of England Governor Andrew Bailey will play second fiddle to other members of the Monetary Policy Committee as he is scheduled to speak on environmental issues. The most pertinent speaker will be the Old Lady's new Chief Economist, Huw Pill, a hawk who has previously aired his concerns over inflation.

EUR

Despite rallying against the dollar last week, the euro is firmly caught in a pincer movement by the policies of the Federal Reserve and the Bank of England. With both of these Central Banks looking to tighten policy, possibly as early as the first weeks of November and the European Central bank some way behind the euro remains vulnerable.

Technically, the euro is also weakened by its low interest rates, making it cheap to borrow, encouraging carry traders to do so, which leads to further selling. A relatively quiet week ahead on the data front, with the highlight being October's flash Purchasing Manager's Indexes released on Friday for both the Eurozone and its constituent countries. With soaring energy costs, Thursday's Consumer Confidence data will be watched more closely than usual to see if consumers are starting to hunker down.

There is also a European Council Meeting taking place on Tuesday, and it would be a significant surprise if no members opined on the state of the EU's economy.

USD

As we mentioned at the beginning of this report, the dollar has given back some of its recent gains, and we will be watching to see if it continues to weaken this week. With a strong economy and the Federal Reserve all but nailed on to start tightening in the next two months, it would be a surprise if the recent weakness was any more than traders booking profits and a relief at the general improvement in the tone of the markets.

The VIX index, sometimes known as the fear index, has fallen from its recent high levels, reflecting an uptick in risk sentiment and a more settled outlook that will help more risk-sensitive currencies, such as sterling, strengthen. A relatively quiet week lies in store on the data front with mainly second-tier data scheduled apart from the Federal Reserve Beige Book release on Wednesday, weekly employment data on Thursday, and Flash PMIs on Friday.

We also have a full slate of speakers from the Federal Reserve to entertain us starting this afternoon with Randal Quarles, tomorrow Miki Bowman and Christopher Waller before Randal Quarles returns to the podium on Wednesday.

SEK

The Swedish krona recorded its best performance for the year last week as beta currencies were once more back on traders' minds. It reached its highest level against the EUR since 2020 on the back of higher than expected inflation figures. This week sees no important data releases but for the Unemployment figure on Thursday. The market is not expecting any major surprises.

Over the mountains in Norway, the Krone extended its bull run and hit another year high against the euro and is trading at levels last seen in late 2019, early 2020 against most G10 currencies. This week we will get the latest Industrial Confidence Survey number on Friday. However, it is not considered a major market event, nor mover, for the Krone.