Parky's quick take: 16 October

What’s in store this week for currencies and FX markets?

Will diplomacy prevail in the Middle East?

This week begins with the Israeli military on the brink of a ground invasion of Gaza. Efforts from governments, including the US, to create conditions for a safe corridor for international citizens to leave Gaza, are ongoing, but so is the Israeli army’s build up on the border with Gaza. The heightened geopolitical tensions have prompted a rise in energy prices and renewed strength in the US dollar, albeit it remains around 1 percentage point from its most recent highs in early October. Will there be a path to peace and a ceasefire? The situation in the Middle East may dominate over the data and survey releases from the major economies over the course of the week, at least in terms of the effect on key financial markets, in my opinion.

Data this week could only complicate central bank decisions

The key releases this week include UK labour market figures for August, the German Zentrum für Europäische Wirtschaftsforschung (ZEW) survey for October, and US retail sales and industrial production data for September on Tuesday, UK September Consumer Price Index (CPI) inflation and Euroland final September CPI inflation figures on Wednesday, the Fed Beige Book release for the 1st November Federal Open Market Committee (FOMC) meeting also on Wednesday, and then UK retail sales and public finances data for September on Friday. These releases could complicate rather than simplify central bank decisions. What happens if the German ZEW survey starts to improve? What if the UK CPI inflation figures point to a rebound in headline and core inflation rates, rather than the falls predicted by the Bloomberg consensus forecast?

Finally, what will the Fed’s Beige Book tell us about underlying economic conditions driving the outlook for the upcoming FOMC decision. Remember that the Fed’s dot plots in September (an assessment of individual Fed member views on where interest rates will be) pointed to one more hike before the end of the year, and there are only two meetings left! The data could be confusing in a lot of ways, given that energy prices have bounced back further recently. Can central banks look past this, or will they be sucked into chasing the data once again?

New dollar strength poses problems for the UK and Euroland

There’s another concern for economies such as the UK and Euroland. The rise in the US dollar could import additional inflationary pressure into these economies. With energy prices higher in USD terms, the weaker the pound and euro are against the US dollar, the greater the effect of these higher energy prices on consumer and producer prices in those jurisdictions. That could make it even harder for the likes of the Bank of England and European Central Bank to look past this jump, in my opinion. That said, the higher that energy prices are, the bigger the potential squeeze on household disposable incomes for discretionary spending. Central banks in the UK and Euroland could be faced with only bad or sub-optimal choices if there are signs of a short-term squeeze higher in inflation because of elements of inflation that interest rates have little or no control over, in my view.

Central banks have more to worry about than just inflation

Meanwhile in the emerging markets, central banks also have more to worry about than just controlling inflation. A mis-step on monetary policy has been seen to bring about a large-scale adverse move in a country’s currency (see what happened to the Polish zloty in early September after a larger-than-expected interest rate cut). Meanwhile the global economy appears to be weakening, at least according to the latest IMF World Economic Outlook. Against this backdrop it is unlikely that either the central bank of Indonesia (Bank Indonesia) or the South Korean central bank (Bank of Korea) will move interest rates this week. There remain concerns over inflation and where it will head in these economies over the course of 2024, but concerns over the weakness in economic activity may be beginning to dominate central bank concerns, in my view. Furthermore, US dollar strength against other currencies, particularly the major currencies, may yet lead to fresh weakness in emerging market currencies also.