We have been warning that the ECB’s plans to wait until 2023 before hiking rates were a pipedream in a world of rising inflationary pressures, and our view was fully vindicated last week.
The massive upwards surprise in the Eurozone January inflation set the stage for Lagarde’s hawkish pivot. Understandably, the common currency soared immediately after the news. A modest dollar rally the next day erased some of the greenback losses on the back of a strong US payrolls report, but the dollar still ended the week at the bottom of the G10 rankings. The euro rose sharply against every major currency, save the Swedish krona.
Traders’ focus will keep shifting back and forth between central bank announcements and inflation data, the factors that will dominate currency markets for the foreseeable future. This week, all eyes are on the US inflation report for January on Thursday, with yet another increase to multi-decade records pencilled in by forecasters. Speeches by ECB officials will also be in focus, which could provide further fuel to the euro rally as the hawkish shift from last week’s meeting is confirmed.
The Czech koruna had quite an eventful week, initially rallying to its strongest position since 2011 only to give up most of its gains following the meeting of the Czech National Bank. The CNB didn’t surprise this time and hiked the two-week repo rate by 75 basis points. At the same time, the bank suggested that significant hikes will likely not be needed and that it plans to reverse some of the recent tightening starting in the second half of 2022. Last week’s decision reinforces our expectation of limited koruna appreciation in the coming quarters. Aside from the CNB we received the fourth-quarter GDP data that were much better than expected (+0.9% QoQ, +3.6% YoY). It’s a positive signal suggesting the post-tightening landing may not be as hard.
Market nerves calmed a bit in that regard but going forward we’ll continue focusing on Russia risk as it has the potential to pressure the currency lower in the event of escalation or increased fears thereof. It’s currently a number one threat to the CEE currencies, in our view.
The Eurozone had one of its most momentous weeks in many months. It started with a massive upward surprise in inflation, and ended with a 180 degree pivot on the topic by President Lagarde at the February meeting of the ECB. Not only are assets purchases to be wrapped up earlier than expected, Lagarde also completely abandoned her pledge to wait until 2023 before lifting rates. The Council is now “unanimously” concerned with inflation, and sees “upside risks” in its future path.
While euro rates had a massive upward move in response, we think that there is still room to go here, and are unsure the ECB can wait until September before raising rates. The euro should continue to remain well supported as markets adapt to the ECB turnabout on policy.
Unusually for a labour report week, the US dollar found itself mostly driven by events across the Atlantic. However, the payrolls report itself appeared very strong in spite of the omicron distortions, with strong job creation, upward revisions to previous months’ data, and wages rising, though not enough to keep up with prices, for now.
Koruna sells off as the CNB signals policy reversal ahead
After rallying to its strongest position since August 2011 against the euro, the Czech koruna sold off sharply following the Czech National Bank interest rate decision.
At the February meeting yesterday the Czech National Bank bank raised its base interest rate by 75 basis points in a 5-2 vote. This marks a continuation of the central bank’s fight against inflation which has increased further into year-end. Core inflation reached 8.6% in December, its highest level on record, and more than four times the country’s inflation target midpoint (2%), while headline inflation increased to 6.6%, the highest level since September 2008. Inflation is expected to remain high in early-2022 before moderating later in the year. Although small rate adjustments may take place in the near term we think the attention will slowly start turning from inflation to Czechia’s growth situation. The country boasts one of the strongest labour markets in the EU, but its GDP has yet to reach its pre-pandemic size, in contrast with many of its regional peers.