UBS On-Air: Paul Donovan Daily Audio 'Perception > reality > reported?'
The desk highlights the divergence in policy expectations surrounding the ECB and the Bank of England ahead of their respective meetings. While the ECB meeting is unlikely to yield significant changes, the Bank of England faces an atmosphere of uncertainty regarding a potential rate cut, given the divisions within its policy committee. Per the full note from UBS, yesterday's inflation data has bolstered the anticipation of a rate cut, with additional cuts expected next year. Additionally, the uncertainty surrounding US inflation data may overshadow broader market narratives today, suggesting a heightened sensitivity to any resultant volatility in the GBP/USD pair.
What the desk is arguing
The desk argues that the upcoming decisions from the ECB and Bank of England will contribute to currency volatility, particularly for the GBP. While the ECB may not change interest rates, the nature of discussions at the BoE, especially related to inflation pressures, could provoke significant market reactions. Per the UBS commentary, recent inflation figures have reinforced expectations for a UK rate cut today, which is pivotal for traders positioning in GBP.
The evidence from the inflation print is compelling, as it provides a backdrop of heightened consumer price perception that could influence monetary policy. As Donovan notes, "a couple more rate cuts are likely next year," suggesting that traders should brace for further shifts in monetary policy that could impact the GBP/USD exchange rate.
Where it sits in our coverage
Our consensus target for GBP/USD stands at 1.075, with a range from 1.04 to 1.12. Specifically, firms like JPMorgan and Bank of America provide contrasting forecasts:
This stance aligns with the desk's assessment that expectations around BoE policy decisions will be a key driver for GBP movement, placing it near the upper bound of the provided range.
How other firms see it
The market narrative appears divided, with JPMorgan and other firms aligned towards a bearish outlook for GBP, anticipating a lower trajectory post-BoE. Conversely, BofA seems counter to this sentiment by maintaining a lower target for GBP/USD. This juxtaposition indicates significant disagreement about how the BoE's forthcoming rate considerations will play out versus market expectations.
Relevant currency pairs to monitor include GBP/USD, which will tightly reflect BoE decisions, as well as EUR/GBP, considering the contrasting stances of the ECB and BoE regarding rate adjustments.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01The ECB's decision is expected to be non-influential, while the BoE faces potential rate cuts amid internal dissent.
- 02Recent UK inflation data has increased market expectations for a BoE rate cut, projecting further cuts next year.
- 03US inflation data may create additional market volatility, impacting GBP/USD positioning.
- 04Diverging views from major banks reflect uncertainty in the GBP trajectory amidst central bank decisions.
Market implications
Traders should pay close attention to GBP/USD as it approaches key levels influenced by the outcome of the BoE meeting. Should the BoE confirm further cuts, positions should align with the anticipated bearish movement in GBP, particularly if fresh inflation data disrupts market expectations.
Risks to this view
A surprise decision from the BoE to hold rates steady amidst inflation concerns could significantly strengthen the GBP, invalidating the current bearish outlook. Furthermore, unexpected shifts in US inflation data that harmonize with a softer US monetary stance could disrupt existing currency pairs involving GBP.
Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's seven o'clock in the morning London time on Thursday the 18th of December. We have central bank decisions today.
The European central bank decision can be dismissed with a shrug of complete indifference. No one thinks they're going to do anything today. The Bank of England has the potential to be more dramatic because there is some uncertainty about the outcome, at least as to the depth of division within the bank's policy-setting committee.
Yesterday's inflation data has reinforced market expectations for a UK rate cut today. A couple more rate cuts are likely next year. Today's release of the November US consumer price inflation data is not going to say very much about the state of inflation in the US economy.
The US Bureau of Labor Statistics has been increasing the amount of guesswork in calculating these numbers, and that will increase still further with this particular release. The survey was conducted later than is normal, and there are no October reference points to interpolate numbers from, and the cycle of sampling prices has been disrupted. There's a reasonable chance of a lower number today to then be superseded by a correcting higher number in December.
However, some of the details will be of some use. While there still will be distortions, measuring the inflation rate of things like foodstuffs or consumer durable goods should still be fairly accurate. There are dangers in political economic terms around the distortions to this month's US inflation data.
While the prices of high-frequency purchases are rising, the perception of inflation is likely to be higher than the reality. If the reported inflation numbers understate reality for technical reasons, then ordinary people are likely to lose trust in those numbers. There are two specific issues around the perceptions of inflation.
Consumers often remember the price level of something that they buy quite frequently for 12 to 18 months. If there is then a one-off price increase, raising the price of a Snickers bar at a vending machine for instance, consumers will not respond well to being told that prices are generally falling because their narrative is it always used to cost $1 and now it costs $1.50. Alternatively, if prices are rising regularly on a month-by-month basis, consumers may not react well to being told that prices are falling, even if that may be true in year-over-year terms.
Thus, while September egg prices were 28% below the highs reached in March of this year in the States, if today's data shows rising egg prices in recent months, that narrative might be more dominant in consumers' minds. It's unlikely that this perception will significantly change consumer behaviour, but it will change reported economic confidence, and of course it may also have political resonance. That's all for today.
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