International Financial Outlook - April 2018 - Bank of Scotland Business
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COMMERCIAL BANKING International Financial Outlook April 2018
Contents
Overview 2
Fundamental Views – G10 FX 3
Fundamental Views – Other Developed Markets FX 5
Developed Market FX Forecasts 6
BRIC FX 7
Key EM Currency Forecasts 8
Interest Rates - UK 9
Interest Rates – US & Euro 10
Inflation 11
Key Economic and Political Events Calendar 12
All historical data sourced from Bloomberg
All forecasts sourced from Bank of Scotland (BoS)
Data sourced 10th April 2017
This document should be regarded as a marketing communication, it is
not intended to be investment research and has not been prepared in
accordance with legal requirements to promote the independence of
investment research and should not necessarily be considered
objective or unbiased.
Marketing Communication | 1Overview
Financial market review – past month this year to 2.25%. It signalled three hikes in 2019, compared
with two previously. Economic growth forecasts were revised
The escalation of global trade tensions has led to further higher following the tax cuts. Fed Chairman Jerome Powell
tightening of financial conditions. The initial announcement of was reticent about the impact of the current trade dispute
US steel and aluminium tariffs, with notable exemptions for with China, but the tightness of the labour market remained a
some countries, was met with China’s retaliatory tariffs of $3bn key focal point for policymakers. Employment growth slowed
on US imports. Further proposed import tariffs on around to 103k in March, but it followed a very strong outturn of 326k
$50bn of some 1,300 Chinese products led to proposed in February, while the unemployment rate remained at the
countermeasures by China of a similar value, including on cyclical low of 4.1%. Wage growth, however, nudged up to
politically sensitive products such as agriculture and aircraft. At only 2.7% from 2.6%.
the time of writing, President Trump responded by instructing
officials to look into potential tariffs on a further $100bn of Following the strongest economic growth in the Eurozone last
Chinese goods. year for a decade, there have been downside surprises in the
data recently. The manufacturing PMI fell to 56.6 in March,
Thus far, the proposed tariff increases seem most likely to be having peaked at 60.6 in December, while the services index
part of a negotiating tactic to wring concessions from China. declined to 54.9 from the January high of 58.0. These levels,
The key uncertainty, however, is how much further the dispute however, are still consistent with above trend economic
will intensify before both sides step back from the brink. A growth, although the risk is that the pace may have
downward spiral of ‘tit-for-tat’ measures has the potential to moderated in Q1. Headline CPI inflation increased to 1.4% in
reduce global economic growth, while also raising inflation. March from 1.1% in February, but underlying price pressures
Increased economic uncertainty in the meantime could also remain subdued. ‘Core’ CPI inflation, which excludes food and
weigh on confidence and activity. energy, was unchanged at 1.0% in March.
Global equity markets remained under pressure, with the MSCI
world index declining nearly 5% over the past month. Longer- Summary of key forecasts
dated bond yields fell in the US, UK and Germany, leading to a
flattening of yield curves, while corporate bond spreads We maintain our forecast for UK interest rates to rise by a
widened. The US 10 year Treasury yield declined below 2.8%, quarter point to 0.75% in May, with a further increase to
while the UK 10-year gilt yield dipped below 1.4% and the 1% in November. Activity in some sectors may have been
German 10-year bund yield fell back to 0.5%. affected by the unusually cold weather, but underlying
economic sentiment has held up. Headline CPI inflation is
Even as trade tensions with China have risen, hopes for a deal
likely to have peaked, but the path back to the 2% target is
in NAFTA negotiations has lifted the Canadian dollar and
forecast to be gradual given some signs that domestic
Mexican peso. The British pound, meanwhile, has been
supported by greater optimism of an eventual Brexit deal price pressures are emerging.
after the agreement on a transitional period. The euro, in The US Federal Reserve raised interest rates for a sixth
contrast, has underperformed following negative data time at its March meeting to 1.75% and maintained its
surprises, which have left markets pondering whether the expectation of gradual hikes. We expect the next rise in
duration of ECB asset purchases might be extended and, with June and a further hike in the second half.
it, a potential delay in the first interest rate rise.
Notwithstanding uncertainties related to the potential rise
The pound has also been supported by expectations that the in global protectionism, strong economic growth boosted
Bank of England will raise interest rates at its May meeting, by tax cuts and a tight labour market will increase
which would be the second increase in six months. At the confidence that domestic inflation will continue to build.
March meeting, two of the nine MPC members dissented
Our view of the ECB remains that it will continue with
from the majority and voted for an immediate rate rise. UK CPI
monthly asset purchases of €30bn until September and
inflation remains above target, despite falling by more than
expected to 2.7% in February from 3.0% in January. The wind down the programme by the end of the year. That
fading impact of higher import prices is expected to be partly would pave the way for interest rates to be raised in the
offset by emerging domestic inflation pressures, with wage middle of 2019. Recent downside data surprises have
growth showing signs of strengthening and with only a increased the risk that policy stimulus will continue for
tentative pickup in recent productivity growth. Moreover, the longer, although some of the softness may prove to be
potential negative impact of the poor weather on economic temporary.
activity, as suggested by the March PMI surveys for
UK and US 10-year bond yields are forecast to rise to 1.8%
construction and services, is expected to be temporary.
Indeed, the GfK consumer confidence index unexpectedly and 3.0%, respectively, by end-2018, and to 2.1% and
rose to 7 in March from 10 in February, while the Lloyds 3.2% by end-2019. In FX, we anticipate GBP/USD to stay in
Business Barometer showed only a marginal fall in overall a broad range, with an end-year target of 1.38, rising to
business sentiment to 32 from 33. 1.42 by end-2019. Our central view is for the euro to
outperform, with the end-2018 forecast for EUR/USD at
In the US, the Federal Reserve raised interest rates by a 1.25, rising to 1.30 by end-2019, and EUR/GBP at 0.91
quarter point to 1.75%, as expected, at its March meeting. The
(GBP/EUR at 1.10), rising to 0.92 (GBP/EUR at 1.09) by
‘dot plot’ of individual policymakers’ projections leaned closer
end-2019.
to four rate rises this year, but overall maintained three hikes
2 | Marketing CommunicationFundamental Views – G10 FX
EUR/USD
EUR/USD
The euro has remained in a narrow range below 1.25. After recording
1.30
the strongest growth in 2017 for a decade, survey and ‘hard’ data
suggest a potential softening of Eurozone economic growth in Q1. The
US economy and labour market remain strong. The slowdown in
1.25 employment growth to 103k in March followed a very strong outturn in
February, while unemployment remained at the cyclical low of 4.1%. The
upward trajectory in US wage growth, however, remains moderate,
which may be evidence of some slack in the labour market. We therefore
1.20 expect the Fed to continue to tighten policy at a gradual pace, with two
further hikes to 2.25% this year. The impact of a global trade war is
difficult to predict. The dollar may benefit if there is comparatively less
1.15
harm to the US economy, but it could also raise the risk premium on US
Actual assets. The ECB, meanwhile, still expects economic growth to remain
Forw ard Implied strong, despite recent signs of a soft patch. The greater risk may be the
BoS Forecast outlook for underlying inflation in the Eurozone, which remains
1.10 stubbornly low. Nevertheless, the central view is that ECB will proceed
Jun 17 Dec 17 Jun 18 Dec 18 Jun 19 with policy normalisation, culminating in the first interest rate rise in mid-
2019. Our EUR/USD target is 1.25 at end-2018 and 1.30 at end-2019.
GBP/USD GBP/USD
1.45 The pound’s post-referendum high in January was more a reflection of
dollar weakness, but its more recent rises may be a result of lower implied
Brexit risk premium and a more hawkish UK policy outlook. The agreement
on a transition period has raised optimism in the markets of an orderly
1.40
Brexit deal. UK economic activity has been broadly resilient, despite
potential temporary effects of the snow. Headline CPI inflation is likely to
have peaked, although fading import price inflation is expected to be offset
1.35 by emerging domestic price pressures. Overall, we anticipate two UK rate
rises this year, in May and November. In the US, employment growth
slowed to 103k in March, but the monthly average in Q1 was still above that
for 2017. Given limited rises in wage growth, we expect Fed policy
1.30 tightening to proceed at a gradual pace, with two further hikes to 2.25%
Actual this year. The economic impact of a potential global trade dispute is
Forw ard Implied uncertain – it might improve relative US performance, but it could also raise
BoS Forecast
the risk premium on US assets. Brexit negotiations, meanwhile, could limit
1.25
Jun 17 Dec 17 Jun 18 Dec 18 Jun 19 near-term sterling strength. Overall, we project 1.38 at end-2018 and to
1.42 at end-2019.
GBP/EUR
GBP/EUR Sterling has risen to 1.15 at the top end of a narrow range that has
1.18 Actual persisted since September. Optimism in the financial markets of an
Forw ard Implied orderly Brexit deal has risen, following the agreement on a transitional
BoS Forecast period, while the UK policy outlook has turned more hawkish. The
1.16
unusually cold weather may have temporarily dented economic activity
in the UK and Eurozone, although negative data surprises this year have
1.14 been more striking in the latter. UK headline CPI inflation, having fallen
to 2.7% in February, is likely to have peaked, but the projected decline
1.12 back to the 2% target is gradual, given emerging domestic price
pressures. Eurozone underlying price pressures, meanwhile, remain
subdued. The ‘core’ measure, excluding food and energy, stayed at
1.10
only 1.0% in March. Overall, we anticipate two UK rate rises this year, in
May and November, although Brexit negotiations may limit near-term
1.08 upside for the pound. In the Eurozone, we still expect the ECB to wind
down the asset purchase programme by the end of this year, paving
1.06 the way for a rise in interest rates from mid-2019. We forecast GBP/EUR
Jun 17 Dec 17 Jun 18 Dec 18 Jun 19 to fall to 1.10 at end-2018 and to 1.09 at end 2019.
Marketing Communication | 3Fundamental Views – G10 FX
USD/JPY
USD/JPY
Actual
120 Until late March, the US dollar had been under pressure against the Japanese
Forw ard Implied
BoS Forecast yen. The deterioration in sentiment – due to concerns over trade and spikes in
equity market volatility ¬– combined with speculation that the Bank of Japan
(BoJ) could remove its easing bias sooner than expected were triggers for
115
JPY strength. At its latest meeting the BoJ left its policy framework
unchanged, with Governor Kuroda once again reiterating his commitment to
ultra-loose monetary policy. The central bank’s efforts to reverse the low
110 inflation environment do appear to be having an effect. The Japanese output
gap recently rose to its highest level in over a decade and Q4 GDP growth
surged to 1.6% (annualised). This, however, is yet to translate into upward
105 price pressures, with ‘core’ inflation for February measuring just 0.5%. For this
reason we believe the BoJ will continue to maintain its accommodative
stance. Given this, the 2-year US-Japan interest rate differential could widen.
Moreover, the reduction in short JPY positioning may enable USD/JPY to
100
Jun 17 Dec 17 Jun 18 Dec 18 Jun 19 move higher more freely. All considered, we see a strong case for the
currency pair to reach 112 by the middle of the year.
AUD/USD
AUD/USD Having made a new multi-year high against the US dollar in late January,
0.82
the Australian dollar softened through the rest of the quarter, falling
towards 0.76. Growing tension between the US and China over trade and a
sustained fall in commodity prices were key factors that pressured
0.80 AUD/USD. Australia finds itself in a difficult position in the trade dispute
given that China is its most significant trading partner, yet the US is its
largest foreign investor. At April’s policy meeting, the Reserve Bank of
Australia (RBA) left interest rates unchanged at 1.50%. Governor Lowe
0.78
showed some concern over the “direction of international trade policy” and
the “outlook for household consumption”. His tone was relatively dovish.
Unsurprisingly against this backdrop, the 2-year Australian-US government
0.76
bond yield differential fell close to its lowest level in almost two decades.
Actual
Forw ard Implied
Yet, with the RBA still forecasting relatively robust GDP growth for 2018 and
BoS Forecast the market not expecting a single interest rate rise this year, the risks to
0.74 Australian rates are, we believe, now skewed to the upside. Assuming trade
Jun 17 Dec 17 Jun 18 Dec 18 Jun 19 tensions subside and global growth remains relatively firm, we expect
AUD/USD to remain range bound, and forecast 0.78 for year-end.
USD/CAD
USD/CAD
Actual
The US dollar has fallen sharply from its mid-March high above 1.31 against
1.32 the Canadian dollar. Mixed US employment reports over the past two
Forw ard Implied
BoS Forecast months and escalating trade tensions between the US and China have
buffeted the USD. At the same time, rising oil prices and the prospect of an
agreement on NAFTA have buoyed the CAD. We expect the decline in
1.28 USD/CAD to continue. The 2-year US-Canada interest rate differential is
near its recent high and, based on current market pricing, the risks to
Canada’s interest rate policy appear to be asymmetric. The alleviation of
uncertainty that would accompany an ‘initial’ NAFTA deal could be a trigger
for the Bank of Canada to adopt a more hawkish stance. This would likely
1.24
drive a narrowing in the rate differential and further pressure USD/CAD.
The unexpectedly sharp rise in Canada’s inflation rate in February, from
1.7%y/y to 2.2%y/y, adds to the argument for tighter-than-expected
monetary policy. Moreover, with the market ‘net short’ of Canadian dollars
1.20 and ‘fair value’ estimated at 1.20, we think there are good reasons to be
Jun 17 Dec 17 Jun 18 Dec 18 Jun 19
bearish on USD/CAD. We expect the pair to fall towards 1.20 by end-2019.
4 | Marketing CommunicationFundamental Views – Other Developed Market FX
NZD/USD
NZD/USD Actual The New Zealand dollar continues to trade in a relatively narrow range against the
Forw ard Implied US dollar. While increased tension between the US and China on trade has
BoS Forecast
0.76 weighed on risk sentiment, the NZD has been supported by milk prices stabilising
near their recent highs close to $3,300 per tonne. From a fundamental perspective,
0.72
little has changed over the past month. The outlook for NZD/USD is likely to remain
responsive to the respective policy stances of the RBNZ and Federal Reserve. The
former left benchmark interest rates unchanged, at 1.75%, at its last meeting.
0.68 Inflation and inflation expectations are still subdued. Therefore, the central bank is
under no pressure to tighten. Having raised interest rates in March, the latter
0.64 continues to suggest two further rate rises are likely this year. We agree with this
Jun 17 Dec 17 Jun 18 Dec 18 Jun 19 assessment. The knock-on impact of diverging central bank policy rates on NZ-US
interest rate differentials should lead NZD/USD lower. We see mild downside risks
to the pair through the coming quarters, forecasting 0.71 at end-2018.
EUR/CHF
EUR/CHF Given its safe-haven status, one might have thought that the Swiss franc would have
1.25 been among the most responsive currencies to the growing tensions between the US
and China and equity market sell-off. This, however, has not been the case. In fact,
1.20 from its February high against the euro, the franc has experienced a near 3%
depreciation, leaving EUR/CHF close to its multi-year highs. Fundamentally, Swiss
1.15 economic data remain relatively firm. Q4 GDP growth rose to 1.9%y/y, while the
unemployment rate has fallen below 3% for the first time since mid-2014. In spite of
1.10 Actual this, inflation, while on an upward trajectory, only rose by 0.8%y/y in February. As
Forw ard Implied such, the Swiss National Bank is unlikely to change its bias towards loose monetary
BoS Forecast
1.05 conditions. Governor Jordan indicated just that, suggesting it will be a “relatively long
Jun 17 Dec 17 Jun 18 Dec 18 Jun 19 time” before the central bank has to adjust policy. In contrast, the ECB removed its
easing bias at its latest policy meeting. Given the prevailing market and monetary
policy trends, we favour EUR/CHF to extend its rally, towards 1.21 by end-2019.
EUR/NOK
EUR/NOK Actual
Forw ard Implied Following a brief spike to 9.88 in early February, the Norwegian krone has rallied to 9.60
BoS Forecast against the euro, but EUR/NOK remains confined to its medium-term range. The krone
10.00
has been supported by the stability of Brent Crude prices and more ‘hawkish’ guidance
from the Norwegian central bank. At its March meeting, the Norges bank left the deposit
9.60 rate at 0.50%. While this was largely expected, the market was caught off-guard by
comments from Governor Olsen, who suggested that policy rates were likely to be
9.20
increased “after summer.” This was much sooner than the market had previously
anticipated. Yet, mixed economic data may leave such an outlook open to debate. It is
true that inflation has risen since sharply since the turn of the year, and is now above target.
8.80 However, retail sales unexpectedly fell in February, while confidence in the manufacturing
Jun 17 Dec 17 Jun 18 Dec 18 Jun 19
sector has also recently declined. Overall, with the krone fundamentally “undervalued”
based on model estimates, we favour EUR/NOK to decline towards 9.30 by end-2018.
EUR/SEK
EUR/SEK The Swedish krona continues to lose ground against the euro, with EUR/SEK
10.40
recently rising to its highest level since January 2010, touching 10.35. In Sweden,
consumer and business activity appear to be under pressure. Retail sales remain
10.10
subdued and key confidence surveys have pulled back from their multi-year highs.
At the same time, euro area data have also started to turn lower. Forward-looking
9.80
indicators, including the PMI surveys, have raised questions over the sustainability of
the bloc’s growth rate. Clearly, any deterioration in European growth will negatively
9.50 Actual impact Sweden, given the region’s importance as a key export market. That said,
Forw ard Implied
BoS Forecast
there are still factors that argue for a stronger krona. Central bank Governor Ingves
9.20 recently suggested it was possible the Riksbank could move interest rates before
Jun 17 Dec 17 Jun 18 Dec 18 Jun 19 the ECB. Moreover, model-driven estimates suggest that the SEK is fundamentally
undervalued. As such, we forecast 9.80 for year-end and 9.55 by end-2019.
Marketing Communication | 5Developed Markets FX Forecasts
Curre nt Jun- 1 8 Se p- 1 8 De c- 1 8 Mar- 1 9 Jun- 1 9 Se p- 1 9 De c- 1 9 Mar- 2 0 Jun- 2 0
Dollar Index (DXY) 89.8 91.7 90.3 89.0 87.6 86.3 85.7 85.6 85.6 85.6
U S Dolla r USD/GBP 0.71 0.74 0.73 0.72 0.71 0.70 0.70 0.70 0.70 0.70
USD/EUR 0.81 0.83 0.81 0.80 0.79 0.78 0.77 0.77 0.77 0.77
GBP/USD 1.42 1.36 1.37 1.38 1.40 1.42 1.42 1.42 1.42 1.42
U K Pound
GBP/EUR 1.15 1.12 1.11 1.10 1.10 1.10 1.09 1.09 1.09 1.09
Effective 78.0 76.2 75.9 75.6 75.8 76.1 75.7 75.7 75.7 75.7
EUR/USD 1.23 1.21 1.23 1.25 1.27 1.29 1.30 1.30 1.30 1.30
Euro
EUR/GBP 0.87 0.89 0.90 0.91 0.91 0.91 0.92 0.92 0.92 0.92
USD/JPY 107 112 110 108 106 104 103 103 103 103
Ja p a nes e Yen GBP/JPY 151 152 151 149 148 148 146 146 146 146
EUR/JPY 132 136 135 135 135 134 134 134 134 134
AUD/USD 0.77 0.77 0.78 0.78 0.78 0.79 0.79 0.79 0.79 0.79
A us tra lia n
GBP/AUD 1.83 1.77 1.76 1.77 1.79 1.80 1.80 1.80 1.80 1.80
Dolla r
EUR/AUD 1.60 1.57 1.58 1.60 1.63 1.63 1.65 1.65 1.65 1.65
USD/CAD 1.27 1.26 1.25 1.24 1.23 1.22 1.21 1.20 1.20 1.20
C a na d ia n
GBP/CAD 1.80 1.71 1.71 1.71 1.72 1.73 1.72 1.70 1.70 1.70
Dolla r
EUR/CAD 1.56 1.52 1.54 1.55 1.56 1.57 1.57 1.56 1.56 1.56
NZD/USD 0.73 0.72 0.71 0.71 0.70 0.70 0.69 0.69 0.69 0.69
New Zea la nd
GBP/NZD 1.93 1.89 1.93 1.94 2.00 2.03 2.06 2.06 2.06 2.06
Dolla r
EUR/NZD 1.68 1.68 1.73 1.76 1.81 1.84 1.88 1.88 1.88 1.88
USD/NOK 7.81 7.85 7.64 7.44 7.24 7.05 6.92 6.92 6.92 6.92
Norweg ia n
GBP/NOK 11.06 10.68 10.47 10.27 10.14 10.02 9.83 9.83 9.83 9.83
Krone
EUR/NOK 9.63 9.50 9.40 9.30 9.20 9.10 9.00 9.00 9.00 9.00
USD/SEK 8.36 8.26 8.05 7.84 7.64 7.48 7.38 7.35 7.31 7.31
Swed is h
GBP/SEK 11.84 11.24 11.03 10.82 10.69 10.62 10.49 10.43 10.38 10.38
Krona
EUR/SEK 10.30 10.00 9.90 9.80 9.70 9.65 9.60 9.55 9.50 9.50
USD/CHF 0.96 0.96 0.95 0.94 0.94 0.93 0.93 0.93 0.93 0.93
Swis s Fra nc GBP/CHF 1.35 1.30 1.30 1.30 1.31 1.32 1.32 1.32 1.32 1.32
EUR/CHF 1.18 1.16 1.17 1.18 1.19 1.20 1.21 1.21 1.21 1.21
Source: Bloomberg, BoS
6 | Marketing CommunicationFundamental Views – BRIC FX
USD/BRL
USD/BRL
Events could not have unravelled more unfavourably for the Brazilian real over the past
3.60
month. Political risk ahead of October’s presidential, legislative and state elections
rose dramatically after Brazil’s former President Luiz Inacio Lula da Silva was jailed.
3.40
This, combined with a surprise 25bps interest rate cut by the BCB and the promise of
further easing in policy, led USD/BRL to break above 3.35 for the first time since May
last year. In light of the recent news, we maintain our view that events in the near term
3.20 are more likely than not to prove unfavourable for the real. Brazil’s fiscal sustainability
Actual
is once again under question from investors due to fears of legislative paralysis, hence,
Forw ard Implied the recent downgrade to Brazil’s credit rating by Fitch. Thankfully, a relatively frim set
BoS Forecast
3.00 of economic data from Brazil should help offset some of the near-term upside pressure
Jun 17 Dec 17 Jun 18 Dec 18 Jun 19 on USD/BRL. At the same time, it is difficult to make a strong case for an immediate
reversal of the past month’s gains. We forecast USD/BRL to end the year at 3.37.
USD/RUB
USD/RUB USD/RUB spiked higher in April after the US applied a fresh set of sanctions against
Russia. Yet even with a spike above 63, the move has not warranted immediate
66.0
intervention. Meanwhile, there are plenty of reasons to expect a sudden reversal of
64.0
recent gains. First, Russia’s improved fiscal position led S&P to restore Russia’s
62.0 investment-grade rating in February. Now, all three major rating agencies have an
60.0 investment-grade rating in place. In addition, Russia’s economy is in recovery, albeit at
58.0 a sluggish pace. At the very least, firmer oil prices compared to last year provide a
56.0
headwind to USD/RUB gains. Still, the risks to our forecasts remain high. Recent
Actual geopolitical events may lead to a permanent rise in the risk premium required to
54.0 Forw ard Implied
BoS Forecast attract investment into Russia. Before the fresh sanctions we also expected the Russian
52.0
central bank would maintain its easing cycle, as inflation remains well below the 4%
Jun 17 Dec 17 Jun 18 Dec 18 Jun 19
target. Lower interest rate will make the ruble less attractive from a carry perspective,
even if crude oil prices move higher.
USD/INR Actual USD/INR
70.0 Forw ard Implied USD/INR managed to consolidate around the 65 level over the past month. Looking
BoS Forecast
ahead, there are plenty of reasons for USD/INR to rise modestly over our forecast period.
68.0 First, India’s economy is highly reliant on crude oil imports. As a result, higher crude oil
prices compared to last year will ultimately raise India’s demand for US dollars. Secondly,
66.0 reform efforts to boost economic activity, a key factor in supporting currency inflows,
have slowed ahead of parliamentary elections in 2019. Finally, and above all, some of
the key valuations metrics point to overvaluation. This, combined with the fact that India’s
64.0
banks and companies continue to wrestle with weak balance sheets, could undermine
investment. Granted, India’s GDP growth accelerated to 7.2% y/y in Q4 last year
62.0
compared to 6.5% y/y in Q3, but we see the risks to future growth projections as skewed
Jun 17 Dec 17 Jun 18 Dec 18 Jun 19
to the downside. We forecast USD/INR at 65.5 at end 2018.
USD/CNY Actual USD/CNY
Forw ard Implied The Chinese renminbi is up by around 3% against the US dollar this year, but we believe
BoS Forecast at current levels it is overvalued. When measured against a PBoC-designated basket of
6.80
currencies, the renminbi is at an almost 2-year high. Granted, much of the recent
upswing has been largely a US dollar move, and therefore unlikely to drive PBoC
6.60
intervention. Nevertheless, should trade-war and tariff rhetoric with the US persists, the
risk of devaluation has increased. Any intervention, however, would represent a retreat
6.40 from promised efforts to liberalise the exchange rate, and therefore risk rebuke from
other trading partners. Even so, the degree to which the renminbi has been thus far
allowed to appreciate would suggest there is a bias for USD/CNY to bounce back from
6.20
its c.6.25 low in coming months. Should the US dollar, retrace some of its losses as we
Jun 17 Dec 17 Jun 18 Dec 18 Jun 19
anticipate, this would only put further upward pressure on USD/CNY.
Marketing Communication | 7Key EM Currency Forecasts
Curre nt Jun- 1 8 Se p- 1 8 De c- 1 8 Mar- 1 9 Jun- 1 9 Se p- 1 9 De c- 1 9 Mar- 2 0 Jun- 2 0
USD/BRL 3.42 3.32 3.35 3.37 3.40 3.42 3.45 3.47 3.47 3.47
Bra z ilia n Rea l GBP/BRL 4.85 4.52 4.59 4.65 4.76 4.86 4.90 4.93 4.93 4.93
EUR/BRL 4.22 4.02 4.12 4.21 4.32 4.41 4.49 4.51 4.51 4.51
USD/RUB 63.5 59.0 58.2 57.5 57.8 58.0 58.1 58.5 58.5 58.9
Rus s ia n
GBP/RUB 89.9 80.2 79.7 79.4 80.9 82.4 82.5 83.1 83.1 83.6
Roub le
EUR/RUB 78.3 71.4 71.6 71.9 73.4 74.8 75.5 76.1 76.1 76.6
USD/INR 65.0 64.5 65.0 65.5 66.0 66.5 67.0 67.5 68.0 68.0
Ind ia n Rup ee GBP/INR 92.0 87.7 89.1 90.4 92.4 94.4 95.1 95.9 96.6 96.6
EUR/INR 80.1 78.0 80.0 81.9 83.8 85.8 87.1 87.8 88.4 88.4
USD/CNY 6.30 6.40 6.42 6.45 6.50 6.52 6.55 6.56 6.58 6.59
C hines e
GBP/CNY 8.91 8.70 8.80 8.90 9.10 9.26 9.30 9.32 9.34 9.36
Renm inb i
EUR/CNY 7.76 7.74 7.90 8.06 8.26 8.41 8.52 8.53 8.55 8.57
USD/CZK 20.6 21.0 20.6 20.2 19.5 19.1 18.9 18.9 18.9 18.9
C z ech Koruna GBP/CZK 29.1 28.5 28.2 27.8 27.3 27.1 26.9 26.9 26.9 26.9
EUR/CZK 25.4 25.4 25.3 25.2 24.8 24.6 24.6 24.6 24.6 24.6
USD/HUF 252.9 257.9 254.3 250.0 245.8 241.9 239.9 239.8 239.6 239.6
Hung a ria n
GBP/HUF 358.0 350.7 348.4 345.0 344.2 343.4 340.7 340.5 340.3 340.3
Forint
EUR/HUF 311.5 312.0 312.8 312.5 312.2 312.0 311.9 311.7 311.5 311.5
USD/PLN 3.41 3.47 3.41 3.35 3.30 3.24 3.22 3.22 3.22 3.22
Polis h Zloty GBP/PLN 4.83 4.72 4.68 4.63 4.62 4.60 4.57 4.57 4.57 4.57
EUR/PLN 4.20 4.20 4.20 4.19 4.19 4.18 4.18 4.18 4.18 4.18
USD/MXN 18.32 18.50 18.40 18.20 18.10 18.05 18.00 17.90 17.90 17.90
Mexica n Pes o GBP/MXN 25.93 25.16 25.21 25.12 25.34 25.63 25.56 25.42 25.42 25.42
EUR/MXN 22.57 22.39 22.63 22.75 22.99 23.28 23.40 23.27 23.27 23.27
USD/ZAR 12.09 13.05 13.10 13.15 13.20 13.25 13.27 13.30 13.30 13.30
South A frica n
GBP/ZAR 17.12 17.75 17.95 18.15 18.48 18.82 18.84 18.89 18.89 18.89
Ra nd
EUR/ZAR 14.90 15.79 16.11 16.44 16.76 17.09 17.25 17.29 17.29 17.29
USD/TRY 4.07 3.90 3.85 3.85 3.75 3.70 3.70 3.65 3.60 3.60
Turkis h Lira GBP/TRY 5.76 5.30 5.27 5.31 5.25 5.25 5.25 5.18 5.11 5.11
EUR/TRY 5.02 4.72 4.74 4.81 4.76 4.77 4.81 4.75 4.68 4.68
Source: Bloomberg, BoS
8 | Marketing CommunicationFundamental Views – UK Interest Rates
UK Pound
Conflicting forces affected UK short- and longer-dated interest rates over the past
% 3m libor
7 month. Rates at the short end of the government yield curve continued to move
5yr swap
6 higher, driven by the sixth rise in US interest rates in late March and growing
10yr swap
5
expectations that the Bank of England will continue to push UK interest rates higher.
At the longer end of the curve, yields continued to ease, as rising trade tensions
4
between the US and China raised concerns about the global growth outlook. As a
3
consequence, the yield curve flattened appreciably, with the spread between 2-yr
2 and 10-yr gilts narrowing to 50bp – the lowest since September 2016.
1 At its policy meeting last month, two (external) members of the Monetary Policy
0 Committee – Michael Saunders and Ian McCafferty – voted to raise UK Bank Rate by a
2006 2008 2010 2012 2014 2016 2018 2020
further quarter point, to 0.75%. The other seven members were content to leave rates
on hold, but noted, amid an ongoing decline in spare capacity, that “some withdrawal
of monetary policy is likely to be appropriate over the coming months”. This is most
likely to occur next month, when the committee revisits its economic forecasts and the
Bank publishes its next quarterly Inflation Report. At the time of writing, the implied
probability the market attaches to a 25bp rate rise in May is around 90%.
Expectations of a May rate rise continue to hold up, despite a slightly more mixed
economic backdrop. In February, the annual rate of consumer price inflation
% Bank Rate
7 dropped by slightly more than expected, from 3.0% to 2.7%. Meanwhile, the latest
BoS forecast
6 purchasing managers’ surveys for construction and services eased back. The
Market implied
5 expectation weakness, however, seems mainly attributable to the extremely poor weather in early
4 March, which hit the construction sector especially hard.
3 Other indicators, notably the labour market data, have remained resilient.
2 Employment in the three months to February surged by 168k, pulling the
1 unemployment rate back down to 4.3%. Pay growth also accelerated to 2.8% – its
0 highest since 2015. Meanwhile, the summary balance reported in the latest Lloyds
2006 2008 2010 2012 2014 2016 2018 2020
Bank Business Barometer was little changed at +32 in March.
Overall, we expect UK Bank rate to rise twice this year – in May and November –
and for the yield on the 10-yr gilt benchmark to resume its gradual ascent, ending
the year at 1.8% (currently 1.4%). This assumes global trade tensions do not
escalate much further.
Key Bond and Money Market Forecasts
C urrent Jun-18 Sep -18 Dec-18 Ma r-19 Jun-19 Sep -19 Dec-19 Ma r-20 Jun-20
Key Policy Rate 0.50 0.75 0.75 1.00 1.00 1.00 1.25 1.25 1.50 1.50
3-month interbank rate 0.8 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6
2-year bond yield 0.9 0.9 1.0 1.1 1.1 1.2 1.3 1.4 1.4 1.5
GBP 10-year bond yield 1.4 1.6 1.7 1.8 1.8 1.9 2.0 2.1 2.2 2.3
5-year swap rate 1.3 1.4 1.5 1.5 1.6 1.7 1.8 1.8 1.9 2.0
10-year swap rate 1.5 1.6 1.7 1.7 1.8 1.9 1.9 2.0 2.1 2.2
Key Policy Rate 1.75 2.00 2.25 2.25 2.50 2.75 3.00 3.00 3.00 3.00
3-month interbank rate 2.3 2.3 2.4 2.6 2.7 2.9 3.2 3.2 3.2 3.2
2-year bond yield 2.3 2.3 2.4 2.6 2.7 2.8 2.9 3.0 3.1 3.2
USD 10-year bond yield 2.8 2.9 3.0 3.0 3.1 3.1 3.2 3.2 3.2 3.2
5-year swap rate 2.7 2.8 2.8 2.9 2.9 3.0 3.0 3.1 3.1 3.1
10-year swap rate 2.8 2.9 2.9 3.0 3.0 3.0 3.1 3.1 3.1 3.1
Key Policy Rate 0.00 0.00 0.00 0.00 0.00 0.10 0.10 0.25 0.25 0.50
3-month euribor -0.3 -0.3 -0.3 -0.2 -0.2 0.0 0.1 0.3 0.3 0.6
2-year bond yield -0.6 -0.5 -0.4 -0.3 -0.2 0.0 0.1 0.3 0.5 0.7
EUR 10-year bond yield 0.5 0.7 0.8 0.9 1.0 1.2 1.3 1.4 1.5 1.6
5-year swap rate 0.3 0.5 0.6 0.7 0.8 1.0 1.1 1.2 1.3 1.4
10-year swap rate 0.9 1.1 1.2 1.3 1.4 1.5 1.6 1.6 1.7 1.7
Source: Bloomberg, BoS
Marketing Communication | 9Fundamental Views – Interest Rates
% 3m libor
US Dollar
6
5yr swap The Federal Reserve raised interest rates at its March meeting by a quarter point to
5 1.75%, in line with expectations. It was the sixth increase since it began increasing
10yr swap
4 rates in December 2015. The updated ‘dot plot’ continued to signal a median of
three rate rises to 2.25% this year, although there was a notable leaning towards
3 four increases, while the median projection for 2019 was raised to three hikes from
2 two previously. The Fed revised up its economic growth forecasts, supported by
fiscal policies, although the projections for inflation were broadly unchanged, as
1 there may be a potential uplift to investment and productivity. Trade tensions with
0 China may yet impact on economic prospects, but policymakers for now maintain
2006 2008 2010 2012 2014 2016 2018 2020 their expectation of gradually rising rates.
Latest indicators point to annualised growth continuing in excess of 2% in Q1,
supported by resilient consumer spending, stronger investment spending and an
inventory rebound. Employment growth slowed to 103k in March, but that followed
a very strong outturn of 326k in February. The average monthly increase in Q1 was
%
6 Fed funds rate about 200k, above the 182k average for 2017. The unemployment rate stayed at
the cyclical low of 4.1%, but wage growth increased only modestly to 2.7% from
5 BoS forecast
2.6%. Policymakers will be watching wage growth very closely to gauge the
4 tightness of the labour market.
Market implied
expectation
3 A downward spiral of ‘tit-for-tat’ tariff measures with China remains a risk to the
2 economic outlook, but our central view continues to be that the Federal Reserve will
raise interest rates two more times this year to 2.25%, with the next hike expected at
1
the June meeting. A further three rate increases to 3% are forecast for 2019. We see
0 further curve flattening over the forecast period, with 2-year Treasury yields seen
2006 2008 2010 2012 2014 2016 2018 2020
rising to 2.6% at end-2018 and 3.0% at end-2019, while rises in 10-year Treasury
yields are forecast to be limited to 3.0% and 3.2% over the same respective periods.
Euro
After the last meeting on 8 March, the European Central Bank removed its ‘easing
6
% 3m euribor bias’ on net bond purchases, increasing the likelihood that they will be wound
5yr swap
down by the end of the year, which would pave the way for interest rates to start
5
rising in 2019. Average monthly net bond buying has already fallen to €30bn, the
10yr swap
4
lowest since the asset purchase programme began in March 2015. At the same
3 time, the ECB has been careful not to attach a definite end date to the asset
2 purchase programme.
1
In 2017, the Eurozone economy recorded the strongest growth for a decade, but
0 more recent data releases point to a possible moderation in the pace of expansion
-1 after the 0.6%q/q increase in Q4. Any softening, however, may prove to be
2006 2008 2010 2012 2014 2016 2018 2020 temporary. The manufacturing PMI fell to 56.6 in March, still well above the 50
growth/contraction level, but it is well below the peak of 60.6 in December. The
services PMI declined to 54.9 in March after reaching a high of 58.0 in January.
‘Hard’ data, such as industrial production and retail sales, also point to a soft start to
the year. In terms of inflation, headline CPI increased to 1.4% in March from 1.1% in
% ECB refi rate February, but the ‘core measure (excluding food and energy) stayed at only 1.0%.
4.5
4.0 The ECB anticipates a gradual rise in core inflation over the projection period,
BoS forecast
3.5 although forecasts in recent years have overestimated the upswing.
3.0
2.5 Market implied
expectation Our central view is that the ECB will continue with monthly net asset purchases of
2.0
1.5 €30bn until September before tapering towards zero by the end of the year, with
1.0
interest rates set to be increased from mid-2019. Policymakers have indicated that
0.5
0.0 a deeper discussion on future policy will take place around the middle of this year.
-0.5
Recent negative surprises in economic data, as well as the potential impact of
2006 2008 2010 2012 2014 2016 2018 2020
rising global protectionism, may increase the ECB’s caution on how quickly to
withdraw policy stimulus. Our baseline forecast is for the main refinancing rate to
rise to 0.25% by the end of next year, while targets for 10 year bund yields are
0.9% at end-2018 and 1.4% at end-2019.
10 | Marketing CommunicationFundamental Views - Inflation
Inflation Rates Inflation Trends
Heightened trade tensions between the US and China have introduced a new
dimension to the global inflation outlook. At this stage, the ‘tit-for-tat’ announcement
of import tariffs and trade sanctions is not expected to have a material impact on the
broader inflation environment, although that could change if the tensions escalate
into a full-blown trade war. While the US and China would be the primary targets, the
resulting rise in import/export prices would likely have wider repercussions.
For now, however, it is largely domestic rather than external considerations that
continue to drive the inflation outlooks in the Eurozone, the US and the UK. In the
Eurozone, the prevailing degree of spare capacity continues to constrain price
pressures. In March, the headline rate of inflation rose from 1.1% to 1.4%, on the
advanced estimate, largely due to a pick-up in food prices. Core inflation,
meanwhile, was unchanged for the third consecutive month, at 1.0%. Both rates
remain well below the ECB’s target ceiling of 2%. More recently, mixed economic
data strengthen our view that any rise in euro area inflation is likely to remain gradual.
In the US, headline inflation continues to edge higher. In February, the annual rate of
consumer price inflation rose to 2.2% from 2.1% the month before. The Fed’s
preferred measure of inflation, the personal consumption expenditure deflator, also
picked up from 1.7% to 1.8% – its highest in almost a year. Although the latest gain in
Inflation Expectations US employment was weaker than expected, this follows a sustained period of strong
jobs growth, which now appears to be putting some upward pressure on wages.
Since last October, annual earnings growth has risen from 2.3% to 2.7%. Rising wage
pressures and the lagged impact of a weak US dollar are expected to put further
upward pressure on PCE deflator over the coming months, justifying additional
policy tightening.
In contrast, inflation pressures in the UK appear to be easing. Having peaked at just
over 3.0% in November, the annual rate of consumer price inflation fell to 2.7% in
February. It should drop further over the coming months as the base effects from the
earlier fall in the pound and the associated rise in import prices continue to fade.
Although the trade-weighted level of the pound is still well below its pre-EU
referendum level, it has risen by over 7% since last August.
While dissipating import price rises should continue to bear down on UK inflation,
rising domestic pressures pose an upside risk. The combination of limited spare
capacity, rising pay growth and weak productivity, are expected to limit the extent
and speed of the fall in inflation over the coming months and quarters. While we
expect inflation to converge back to around 2% over the medium term, this is likely to
require further, albeit ‘limited and gradual’, rises in interest rates.
Inflation Outlook
Avg since '97 Latest Period '18 Q1 '18 Q2 '18 Q3 '18 Q4 '19 Q1 '19 Q2 '19 Q3 '19 Q4
GBP CPI inflation % 2.0 2.7 Feb-18 2.9 2.7 2.6 2.4 2.2 2.2 2.2 2.2
USD CPI inflation % 2.2 2.2 Feb-18 2.2 2.5 2.4 2.2 2.2 2.2 2.2 2.2
Core CPI inflation % 2.0 1.8 Feb-18 2.0 2.2 2.3 2.2 2.2 2.2 2.2 2.2
PCE deflator % 1.8 1.8 Feb-18 1.9 2.0 1.7 1.8 2.0 2.0 2.0 2.0
Core PCE deflator % 1.7 1.6 Feb-18 1.8 1.9 2.0 2.0 2.0 2.0 2.0 2.0
EUR HICP inflation % 1.7 1.4 Mar-18 1.3 1.5 1.7 1.7 1.6 1.6 1.6 1.6
Core HICP inflation % 1.4 1.0 Mar-18 1.0 1.1 1.2 1.4 1.5 1.5 1.6 1.7
Source: Bloomberg, BoS
Marketing Communication | 11Key Economic and Political Events Calendar 2018 Central Bank Meetings 2018 Political Events APRIL APRIL Country Date Event Country Date Event EZ 26 ECB rate decision MAY MAY Country Date Event Country Date Event US 2 FOMC policy announcement UK 3 Local elections UK 10 BoE MPC announcement + Inflation Report EU 17 EU Summit JUNE JUNE Country Date Event Country Date Event US 13 FOMC policy announcement + press conference EU 28/29 EU Summit EZ 14 ECB rate decision UK 21 BoE MPC announcement JULY JULY Country Date Event Country Date Event EZ 26 ECB rate decision AUGUST AUGUST Country Date Event Country Date Event US 1 FOMC policy announcement UK 2 BoE MPC announcement + Inflation Report SEPTEMBER SEPTEMBER Country Date Event Country Date Event UK 13 BoE MPC announcement UK 30/9 - 3/10 Conservative Party Conference EZ 13 ECB rate decision US 26 FOMC policy announcement + press conference OCTOBER OCTOBER Country Date Event Country Date Event EZ 25 ECB rate decision EU 18/19 EU Summit NOVEMBER NOVEMBER Country Date Event Country Date Event UK 1 BoE MPC announcement + Inflation Report US 6 Midterm elections US 8 FOMC policy announcement DECEMBER DECEMBER Country Date Event Country Date Event EZ 13 ECB rate decision EU 13/14 EU Summit US 19 FOMC policy announcement + press conference UK 20 BoE MPC announcement Source: Bloomberg, BoS 12 | Marketing Communication
Contacts
Research Global Corporate FX
Jeavon Lolay Eric Wand Anders Nilsson
Head of Economics & Strategy Rates Strategist +44 (0)20 7050 6006
Tel: +44 (0) 20 7158 1742 Tel: +44 (0) 20 7158 8231 anders.nilsson@lloydsbanking.com
jeavon.lolay@lloydsbanking.com eric.wand@lloydsbanking.com
Mid Markets & SME
Adam Chester Robin Wilkin
Head of Economics Cross Market Strategist Lars Olesen
Tel: +44 (0) 20 7158 1740 Tel: +44 (0) 20 7158 1637 +44 (0)20 7158 6252
adam.chester@lloydsbanking.com robin.wilkin@lloydsbanking.com lars.olesen@lloydsbanking.com
Carl Paraskevas Gajan Mahadevan Financial Institutions
Senior Economist FX Strategist
Adrian Walkling
Tel: +44 (0) 20 7158 1741 Tel: +44 (0) 20 8975 5016
+44 (0) 20 7158 1888
carl.paraskevas@lloydsbanking.com gajan.mahadevan@lloydsbanking.com
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Tel: +44 (0) 20 7158 1749
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