G10 FX Weekly – Local developments take over

by: Georgette Boele , Roy Teo

G10-FX-Weekly-23-July.pdf (145 KB)
  • BoE rate hike is back into focus
  • Commodity price weakness weighs on Canadian and Australian dollars
  • We see downside risks to our year-end NZD/USD forecasts




BoE rate hike is bank into focus…

Some months ago, the sentiment on sterling was very negative. For a start, the prospect of a hung parliament weighed on sterling ahead of the elections in May. In addition, financial markets had pushed out the start of the Bank of England (BoE) tightening cycle to May of 2016. Last week, BoE Governor said that officials are edging closer to tightening policy as the economic recovery continues. This resulted in an upward adjustment in rate hike expectations and supported sterling. However, financial markets underestimate the amount of rate hikes in our view. We expect the BoE to start hiking at the November meeting, by 25bp. This should result in a rise in sterling versus euro. However, sterling will likely move lower versus the US dollar, because market expectations on the US Federal Reserve are even more dovish than on the BoE. We expect two rate increases of 25bp by the Fed this year, while only one rate increase by the BoE.



Lack of data and weaker earnings’ reports weigh on USD

At the start of the week, the US dollar was strong. However during the week, the sentiment deteriorated somewhat. For a start, there was a lack of important US data releases so the US dollar bullish momentum could not gain momentum on stronger-than-expected US data. In addition, weaker-than-expected corporate earnings’ reports in the US pushed US equities lower, which weighed on the US dollar. Looking ahead, we expect EUR/USD to move to parity on monetary policy divergence. A stronger-than-expected US Q2 GDP next week should put a such move in motion.

Commodity price weakness weighs on CAD and AUD

The Canadian dollar and Australian dollar moved lower this week as commodity price weakness was felt. In addition, the Australian dollar (AUD) was sold off after core inflation edged lower in the second quarter, resulting in expectations of more rate cuts to come. However, losses were minimised after Reserve Bank of Australia (RBA) governor Stevens warned that monetary policy should not be used to respond to short term market events. Nevertheless, Stevens did not rule out further rate cuts. We maintain our bearish view in the AUD, expecting further declines towards 0.7200 by the end of this year. Any relief recovery towards 0.7550 is unlikely to be sustainable.

Downside risks to our NZD forecasts

The New Zealand dollar (NZD) recovered to around 0.6650 after the Reserve Bank of New Zealand (RBNZ) lowered the Official Cash Rate by 25bp to 3%, amid some speculation that a more aggressive rate cut might be warranted. The RBNZ was less dovish on the exchange rate but reiterated that further depreciation in the NZD is necessary, given weakness in export commodity prices. Further monetary easing also seems likely. We see downside risk to our year-end NZD/USD forecast of 0.6500. We will publish our new forecast in our FX conviction report to be released on 24 July.