GBP

Bank of England Governor Bailey and Chief Economist Pill suggested last week that a hike in interest rates may be on the cards as early as the next meeting of the MPC in early-November. Futures markets have reacted aggressively, and are now fully pricing in the first pandemi era rate hike at next Thursday’s MPC meeting. We expect to see a 15 basis point move in rates, with another 25 basis point hike now looking likely to follow in February.

Strong increases in house prices and overall inflation continued in October and September respectively, while the PMIs also surprised pleasantly to the upside last week, despite ongoing supply shortages. All in all, the rather muted reaction to the positive news in sterling is a bit puzzling, albeit the UK currency continues to trade just shy of its strongest position since mid-September versus the dollar. This week, all eyes should be on the release of the UK government’s budget on Wednesday. We will be paying close attention to the impact of sooner-than-expected interest rate hikes on the government’s updated growth forecasts.

EUR

In contrast to the US and the UK, the Eurozone PMIs slipped, although they remain at high levels consistent with continued strong growth. The key event for this week is, of course, the European Central Bank’s October meeting on Thursday. Once again, no change in policy is expected, and the focus will be on communications from the council, with markets expecting a very dovish ECB.

However, it’s worth noting that the gap between the ECB’s September projections for future inflation and reality has only widened. Another increase is expected when the October preliminary data is released the day after the ECB meeting. Given market expectations, even a neutral tone from President Lagarde would probably result in a sharp euro rally.

USD

While higher Treasury rates have usually been a positive for the US dollar, on this occasion this backup is being entirely driven by rising inflation expectations rather than hope for better real returns. Chair Powell last week all but confirmed that the taper will begin in November, but this provided little help to the greenback, which dropped against most of its G10 peers.

This week’s combination of third-quarter growth and inflation data should provide clarity on the stagflation issue; we are of the view that the current environment is clearly inflationary, but also relatively growth friendly, and expect positive surprises on both fronts. We still see plenty of room for market’s projections of Fed hikes to be brought further forward in time, in spite of recent moves in that direction.

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