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UK inflation data in focus
Focus on today’s UK inflation report
Later this afternoon, the UK will release April’s inflation report. Following last week's BoE meeting, investors will undoubtedly react negatively to an upside surprise in inflation. Indeed, Mark Carney warned that UK consumers will be squeezed this year as price pressures pick-up. Headline inflation is expected to come in at 2.6% y/y from 2.3% in the previous month, while the core measure should rise from 1.8% y/y to 2.3%.
The BoE made clear that it won’t raise borrowing costs should inflation pressure be fuelled by further GBP weakness, they would only do so if the UK gets a good divorce deal with the European Union. GBP/USD was up 0.40% this morning amid a broad-based USD sell-off. However, the pound lost ground against the single currency amid renewed hopes for a stronger European Union following Emmanuel Macron taking office.
EUR/GBP returned to 0.8537 on Tuesday morning and is currently trying to break its 50dma, which currently stands at 0.8541, to the upside. We maintain our long EUR / short GBP view on the pair, especially since Macron and Angela Merkel seem to want a closer relationship in order to shake up Europe. That does not bode well for the Brexit negotiation as it increases the odds that the EU will take a tougher stance towards the United Kingdom.
US data on deck
The lack of a real driver has created choppy directionless trading. Yet for today, traders' attentions will focus back on the US data for support of the Fed policy path. After yesterday’s fall in the Empire State manufacturing headline index, expectations for evidence of economic strengthening will be needed. Much of the optimism around the US economy was driven by sentiment surveys, which in recent reads have declined from the elevated reading that came post-US election. That said, data coming from the US housing sector remains solid as the NAHB housing index rose to 70 in May from 68 in April. Today’s Industrial Production should moderate from March's 0.5% rise to 0.4%.
Yet given the volatility in the indicator plus recent deceleration in sentiment, there is room for a downside disappointment. Housing starts with homebuilding activity strong and after a weak read in March, markets expect a recovery of 3.7% m/m.
There is also healthy consumer demand and solid labour markets (which is finally seeing wage gains) and while building permits should weaken slightly after a strong March down 0.2% from 3.6%, there is room yet for a quickening pace as the weather has been unseasonably warm. Weaker US data and domestic political confusion has dimmed expectations both for a faster Fed hiking cycle and faith in the USD (DXY fallen to 98.78 from 99.88).
However, the resilience of US short end yields suggest longer-term support for the USD. We caution investors from becoming too bearish on the USD ahead of 14th June Fed rate decision. The stability in US rates is the primary reason the USDJPY has not corrected further of the 114.38 resistance barrier.
Strong German economy brings optimism
The Eurodollar pair has broken 1.1000 following the French Presidential election. It seems markets are now leaving European political uncertainties behind. Yesterday, new French President Emmanuel Macron met with German Chancellor Angela Merkel and said he is willing to accelerate European construction, in particular the fiscal side.
For financial markets, the demand for euro is growing. In Germany, the ZEW confidence index - a survey of around 300 economists - is set to be issued and the consensus estimates the current situation in Germany is better. The German economy has been strong for the first quarter and investment and retail sales have been the key driver.
It is worth noting that Germany has a massive trading surplus and this is because the euro is way too low, given the strength of the country's economy. We reload our EUR bullish positions for the time being.