Interest rates cut expected this week in Europe, Japan spends $62bn to support its currency

Hello from London! 🇬🇧

This week we continue our tour of the EEA, and we're traveling to Iceland and its magnificent landscape, volcanoes and northern lights.

Iceland is known for its Scandinvian heritage after Norse travellers on a viking expedition ("fara i vikingu" in old Norse, as viking is the term for the activity or piracy and pillaging, as opposed to the term for the people practicing it, ie. the Norse, Danes and Swedes) settled in the 9th Century.

A very often unknown fact about Iceland is that it won a series of three distinct military confrontations against the United Kingdom, West Germany and Belgium despite having no standing army. The confrontations were later named the "Cod Wars", and there's a brilliant video from Johnny Harris if you would like to learn more about it.

Here's a quick recap of the past week movement on the main pairs, weekly economic news and what to expect for the week ahead.

🇬🇧 GBP

Over the last month, the big piece of news has been the Bank of England leaving rates unchanged, leaving the base rate at 5.25%.

Despite a "growing" economy, with a 0.6% growth rate for Q1 2024, inflation remains higher than the annual growth rate with CPI standing at 3.2% for April. This means prices are rising faster than the rate at which value is created within the economy, and therefore prices are increasing faster than the growth rate of the economy.

Cable is also trading near a 1.2750 support level, cable generally falling this year with the dollar gaining strength, although it has picked up from the mid 1.25 around the middle of last month.

On a positive note, PMI are in expansion with a composite PMI of 55.0, showing growing manufacturing and services industries.

This week, we'll keep an eye on the BRC Retail sales figures, and the Halifax House Price index, with May already expected to see an increase for the first time in three months.

🇪🇺 EUR

In Europe the last month has been very quiet with banks holidays cutting the week short for many and EUR/USD remaining stable around support in the 1.08-1.09 area.

PMIs are also in expansion in France, Germany, Spain and Italy, and first interest rate cuts in Sweden. This could be followed very soon by a cut by the European Central Bank as inflation is currently around 2.6%, and close to target set by the ECB mandate.

Last week's inflation figures showed however that inflation had picked up from April, as it jumped from 2.4% in the Eurozone to 2.6%, leading markets to expect now fewer cuts from the European Central Bank this year, with the main question being when to expect the next cut.

Should the ECB choose to cut rates on this week the 6th of June, we could see EUR/USD fall as low as the 1.05 as the expectations remain on an ECB. Christine Lagarde and the ECB have been quite clear there should be a cut this week.

Therefore, most market makers currently expect USD to strengthen against the EUR, in part because higher interest rates in the US make American bonds more attractive, and therefore attracts more demand for the greenback. However, if the ECB decides to do nothing yet, this could push EUR/USD to the 1.09-1.10 in the near future and until their next rate cut.

🇺🇸 USD

Last week’s US inflation data showed a softening trend. The Federal Reserve’s preferred gauge for inflation, Core PCE (Personal Consumption Expenditures), advanced at the slowest pace this year.

The revised Q1 GDP figures at 1.3% also showed a slower than expected growth of the US economy in the period. Inflation figures in the last month were also disappointing, coming out at 3.4%.

The figures demonstrate the tricky situation in which the federal reserve is in with a tight monetary policy in place but inflation failing to drop over the recent months, and in fact actually rise by 0.4% in April, leading even Fed policymakers to disagree about the current credit conditions.

This pushes expectations of Fed rate cut towards the end of the year and makes the greenback strong against its main peers like the JPY, the EUR, or the GDP.

The highlight of the week will be the release of the May’s Nonfarm payrolls. This report should hint again that interest rates are restrictive enough and that they are not.

The US Dollar trades lower today as the markets wait for US ISM Data later today. This data should provide further information on how strong the economy is.

🇺🇳 Other

Japan has intervened over the last months in the foreign exchange markets to support the yen, spending about $62 billion. This is the first time Japan has intervened in the forex markets since 2022.

The Japanese finance ministry data showed that forex intervention operations totalled 9.79 trillion yen ($62 billion) between April 26 and May 29. This intervention was done to bolster the yen, which had hit a 34-year low, around the USD/JPY 157.31 mark. While a weaker yen is good for Japanese exporters and foreign visitors, it makes imports and outbound travel more expensive.

The Japanese currency has significantly fluctuated from around 115 per dollar before Russia’s February 2022 invasion of Ukraine. In early May, the yen weakened to its lowest level since 1990 around 157 per dollar, but then suddenly jumped more than 3%.

The sudden jump in the yen stoked speculation among market-watchers that the government had sold dollars and bought yen for the second time in a week to support the Japanese currency. Japan’s government last intervened in markets to support the yen in October 2022, when it spent 6.3 trillion yen on forex intervention operations. Authorities also sold dollars in September 2022 in an intervention that cost 2.8 trillion yen. Japan has a lot of firepower for interventions with about $1.1 trillion of forex reserves.

The intervention boosted the currency but may not prop it up long-term as we see this morning the yen still trading around 157 per dollar.

This plunge is due in part to the Bank of Japan’s policy of maintaining ultra-low interest rates while other central banks have hiked theirs. In March, the Bank of Japan hiked interest rates for the first time in 17 years.

Open rates week 13/05/2024:

• EUR/USD: 1.0852 (-0.04%)
• GBP/USD: 1.2732 (-0.01%)
• EUR/GBP: 0.8516 (-0.08%)
• USD/CNY: 7.2437 (-0.01%)
• EUR/CNY: 7.8580 (-0.05%)
• USD/CHF: 0.9032 (-1.41%)
• EUR/CHF: 0.9799 (-1.43%)
• USD/JPY: 157.32 (+0.20%)

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If you would like to have better management over your foreign exchange exposure, at GPS Capital Markets, LLC we can help with netting solutions, options, forward contracts and FX credit lines contact me at jdufour@gpsfx.com or call me on +44 (0)20 3146 1476 or book a meeting with me at this link: Book time with Julien Dufour: FX Risk & Treasury Management | GPS Capital Markets

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