There has been a massive turnaround in central bank priorities over the past few weeks, as shown by the Fed hawkishness, the Bank of England’s unexpected hiked rates, and the budding dissent within the ECB council. As the news flow turns light into the holidays, traders will be paying close attention to the omicron variant news. Into the New Year, the different pace of central bank tightening will continue to be the key driver in currency markets.

GBP

UK November inflation delivered another nasty surprise, rising above expectations to 5.1% for the year. This may have been the catalyst for the surprise hike by the Bank of England, after a notably hawkish 8-1 vote. This completely dumbfounded expectations – an 8-1 vote in favour of no change in rates looked far more likely in the lead up to the meeting given the thoroughly dovish comments from a handful of MPC members in the past few weeks.

The Bank mentioned specifically a tight labour market and inflationary pressures as justifications for the move. We think there is potential for a continued sterling rally into year end, given the paucity of data, the positive news from the central bank, and a market that is still very short the currency and may be forced to cover in the thin holiday season.

EUR

The ECB clearly will lag its global peers in this tightening cycle. However, we think there were subtle but clear signs that the institution is shifting its view on inflation and taking a more hawkish stance.

The inflation forecasts were revised sharply higher. Also, the omicron variant was cited as a potential cause of additional inflation. Finally, President Lagarde suggested the existence of a hawkish dissenting faction within the Council, admitting the decision was not unanimous. For now, however, Lagarde insists that a 2022 hike remains “very unlikely”, and the euro struggled to find a footing all week long.

USD

As expected, the Federal Reserve doubled the speed of the taper and will wrap up its bond purchases no later than March. However, Fed communications, notably the “dot plot”, were more hawkish than most expected. Fed members now expect to hike rates three times in 2022, and it’s clear that the March meeting is now a live one in terms of the possibility of a hike. Chair Powell suggested that the central bank is much more worried about inflation than at the previous meeting, and that it sees the labour market as close to full employment.

While we retain our generally positive outlook on the US economy, one of the key uncertainties is what will happen to US rates once the Fed’s massive support for the Treasury market disappears, as bond purchases end on or before March of next year.

CHF

After a volatile few days, EUR/CHF returned back to the 1.04 mark. The centre of attention last week was the Swiss National Bank meeting. The SNB increased its inflation forecast for the short- and medium-term, although the changes were quite limited as the bank now expects consumer prices to grow by 0.6% in 2021, 1% in 2022 and 0.6% in 2023 compared to 0.5%, 0.7% and 0.6% respectively in September. The SNB also expects slightly higher GDP growth in 2021, of around 3.5% compared to around 3% estimated in September.

Somewhat surprisingly, the rhetoric regarding the franc did not change. Importantly, SNB president Jordan mentioned in his remarks that ‘[the SNB has] been able to prevent a stronger rise in inflation in Switzerland by allowing a certain amount of nominal appreciation’, confirming our suspicions. He did stress that too strong of an appreciation could be negative for growth and even, under certain circumstances, cause deflation. This suggests that there’s a limit to the SNB’s acceptance of a stronger currency, but not changing the language with regards to the franc in the statement coupled with a low bar for inflation surprises given only slightly altered inflation projections suggests that this tolerance could be quite broad.

AUD

The Australian dollar ended last week trading around the 0.72 level versus the US dollar. AUD remains under pressure as Reserve Bank of Australia governor Philip Lowe reiterated last week that the central bank would keep interest rates at a record low in 2022. Strong jobs data published last week did, however, raise the likelihood that the central bank will wind down its pandemic-era stimulus early next year. Australia’s seasonally adjusted unemployment declined to 4.6% in November from 5.2% the previous month and below market estimates, as COVID-19 lockdown were lifted. The Australian composite PMI decreased to a two-month low of 54.9 in December from 55.7 a month earlier. Still, this marks the third consecutive month of expansion in the private sector since June.

The RBA’s most recent meeting minutes will be released on Tuesday in an otherwise relatively quiet week.

CAD

The Canadian dollar ended last week trading around 1.28 versus the USD, after touching a 16-week low of around 1.29 against the US dollar earlier in the week. Canada’s inflation rate remained at 4.7% in November, its highest rate since February 2003, the same rate as the previous month’s and in line with market expectations. Prices rose in all of the eight main components, with the greatest pressure coming from transportation (10%), supported by gasoline (43.6%). On a monthly basis, consumer prices advanced 0.2%, in line with market expectations and easing from the 0.7% increase in the previous month.

Retail sales data will be published on Tuesday, although this is for October and therefore runs on quite a bit of a lag. We will be paying much closer attention to the November GDP print on Thursday, which is expected to show a rather marked acceleration in growth from a month previous.

CNY

The Chinese yuan sold-off slightly against a broadly stronger US dollar last week. The currency seems to have lost some of its resilience after a week earlier the PBoC took steps suggesting a rapid appreciation isn’t welcome. The central bank continued to ease its policy last week. The rate on the 1-year medium-term lending facility was unchanged last week, but the rollover of maturing loans to a tune of 500 billion yuan was on the dovish side of expectations. Today the bank announced a small, 5 basis point cut to its 1-year loan prime rate (now 3.8%), leaving the 5-year unchanged. A number of other measures announced earlier, including a recent RRR cut, came into effect last week.

Last week’s economic data from China pointed to weaker economic activity in November, with retail sales particularly disappointing. It adds to the argument of policy easing and further steps the PBoC might be on the horizon if data continues to print short of expectations.