GBP

Sterling tends to suffer during bouts of risk aversion in financial markets, and last week was no exception. Comments from MPC members suggesting they are taking a cautious approach to the omicron variant did not help matters either. Catherine Mann noted her view that it was premature to start thinking about raising interest rates, while one of the most hawkish members of the committee, Michael Saunders, also said that he wanted more information on the new variant before deciding on how to vote this month.

We still think that the decision on whether to hike in December will be finely balanced, and look to Broadbent’s speech on Monday for confirmation that he’s taking a more hawkish view. If so, we believe there is a lot of pent up potential for a pound rally, as it has been excessively punished over the past couple of weeks, particularly against the US dollar.

EUR

The common currency has held up surprisingly well through two weeks of risk aversion and hawkish noises from the Federal Reserve. The massive upward surprise in Eurozone November inflation last week should make President Lagarde’s extreme dovishness increasingly untenable.

In particular, the 21.9% print in producer price inflation all but guarantees that inflation levels will not be coming down anytime soon, as those price pressures bubble up through the supply chains to the final consumer. Of particular note should be the German inflation number of 6%. We expect some hawkish pushback against Lagarde’s dovish line to emerge soon in the wake of these ugly numbers, and remain of the view that ECB interest rate hikes cannot wait until 2023.

USD

Chair Powell’s hawkish turnaround last week is a remarkable development, albeit one we have long expected. He explicitly stated that the word “transitory” should be retired when discussing the current inflationary episode, and suggested he’s ready for a significant increase in the pace of the tapering of bond purchases at the December meeting.

The mixed US labour report for November is unlikely to have changed this view. While the job creation headline was disappointing, the household survey’s unemployment numbers all dropped sharply, suggesting that the US economy is at or very near full employment and that little relief on inflationary pressures will come from supply side expansion. The inflation report this week should be another one for the record books, going back to many decades and cementing the Federal Reserve’s newfound resolve to fight inflation pressures through monetary tightening.

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