It has been a defining week for the US dollar with Janet Yellen finally announcing a long awaited rate hike. As our reports have been alluding to in the months prior to the announcement, we saw the US Federal Reserve raise interest rates by 25 basis points from 0.25% to 0.5% – its first increase since June 2006. In addition, the US central bank raised its projection for economic growth next year from 2.3% to 2.4%, which suggests the bank does not think the rate increase will damage growth. The rate rise vote was unanimous and the bank cited as the reasons for its action increased household spending and investment by business, along with a continued low rate of inflation. The committee said: "The committee judges that there have been considerable improvements in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2% objective."
Janet Yellen’s opening statement outlined that this decision now "marks the end of an extraordinary seven year period" whereby the world has experienced the "worst financial crisis and recession since the Great Depression". The Fed's actions have acted as a catalyst in the process of "restoring jobs, raising incomes and easing the economic hardship of millions of Americans". She said the recovery has come "a long way"; however it is "still not complete".
Going forward, the U.S. Federal Reserve will likely raise interest rates again in the next three months according to two-thirds of economists polled by Reuters, although many say rates won't rise as quickly next year as policymakers have suggested. However, one must bear in mind that Yellen made explicit reference to this being a "gradual" process. Defining "gradual" and determining how the FOMC will implement a "gradual" rate increase will become key to how the markets trade going forward.
In addition, considering the muted outlook for inflation and oil prices, a strong dollar hurting U.S. manufacturers, and the continued fragile state of the global economy, the Fed may have to be cautious with future rate hikes. Nonetheless, 77 of 120 economists in a snap poll conducted a couple of days after the meeting, said rates will next move higher by March. And all others but two said it would happen in the second quarter. Compounding this, Fed policymakers - whose views are visually plotted and published by the Fed as dots - currently estimate rates at 1.25-1.50 percent by the end of 2016, 100 basis points higher than the current rate.
Prior to the interest rate hike, underlying US inflation rose in November which evidently gave credence to the Federal Reserve raising their interest rates despite renewed weakness in oil prices keeping overall U.S. consumer prices in check.
Further, we the saw Core Consumer Price Index, which excludes food and energy, increase 0.2 percent last month - it was the third straight month that the core CPI has increased by that margin. In fact, in the 12 months through November, the core CPI rose 2.0 percent, the largest gain since May 2014, after rising 1.9 percent in October.
Now with the Christmas period in full swing which is typically light on data, greenback will continue to gradually strengthen next year. With regards to the Euro, industrial production in the Eurozone rebounded in October after two months of decline, according to new figures released this morning.
On the year, industrial production across the currency bloc was up 1.9 per cent against a 1.3% consensus. Output from Eurozone factories, quarries and mines, jumped 0.6% in October compared with -0.3% the previous month. The figures, published by Eurostat, the statistical office of the European Commission, showed the biggest annual gain was in durable consumer goods, which includes things like fridges, cars and mobile phones.
Further, production of durable consumer goods was up 4.2 per cent. The fastest annual growth was in Ireland, where production is 14.6 per cent higher. It also climbed at healthy rates in France, Spain and Italy, but declined 0.1 per cent in Germany, the Eurozone's biggest economy. Germany plans to raise some 210 billion euros ($231.76 billion) by issuing bonds and similar debt instruments in 2016, nearly 13 percent more than it borrowed this year.
In addition, German business confidence unexpectedly slipped in December in a sign that companies are concerned about the risks facing Europe’s largest economy. The IFO institute’s business climate index dropped to 108.7 from 109.0 in November. The Bundesbank kept its 2016 growth projection unchanged at 1.8 percent this month, arguing that the economy is benefiting from “lively” domestic spending even as the export-oriented manufacturing sector suffers from uncertainty in emerging markets.
With a renewed drop in oil prices undermining efforts by the European Central Bank to boost inflation in the euro area and a refugee crisis testing the region’s political resolve, risks to the outlook have increased. As an overview, we have seen GBP/EUR from a high of 1.3846 and a low of 1.3703 and EUR/USD from a high of 1.1031 to a low of 1.0809.
Turning to the pound, The Bank of England deputy governor Minouche Shafik has said she will not vote for an interest rate rise until she is convinced wage growth has recovered. In the latest sign from policymakers that borrowing costs will remain on hold well into 2016, Shafik noted signs that the rate of earnings growth in the UK had “levelled off” recently and that other factors were also keeping inflation low, such as the strong pound and a drop in commodity prices. Shafik saw several possible explanations for wage growth easing off: that the number of hours worked per person per week may have started to decline; that employment growth has been skewed towards lower paid jobs; and that the low level of headline inflation may be leading to less generous pay rises.
Also worthy of note is that the UK’s inflation rate edged back above zero in November for the first time in four months, a move that still leaves the rate a long way from the Bank of England’s target of 2%. Prices rose an annual 0.1 percent in November after falling 0.1 percent in October, said the Office for National Statistics. Core inflation, which excludes volatile food and energy prices, accelerated to 1.2 percent from 1.1 percent.
The BOE expects inflation to remain below 1 percent until the second half of next year and only reach its 2 percent goal in late 2017. The figures follow a warning from BOE officials this month about weak inflation filtering through the economy and flattening out wage growth. BOE Deputy Governor Minouche Shafik said on Monday that she would wait for wage growth to be sustained at a level consistent with inflation returning to target before voting for an interest rate increase. UK wage data being released this morning is forecast to show that annual income growth has slowed from 3 percent to 2.5 percent. Average earnings in the U.K. increased less than expected in the last three months of the year, reducing the case for higher interest rates. The average earnings index including bonuses rose by 2.4% in the three months to October; this came in below the forecast for a gain of 2.5% data released yesterday showed that the jobless rate in October fell to the lowest level since mid-2008. The rate of unemployment dropped to 5.2% in the three months to October. The Pound was also boosted when UK retail sales rose by more than expected in November, as shops offered promotions at the end of the month in the run up to Black Friday. Sales volumes increased by 1.7% in November from the month before, the Office for National Statistics said.
However, in spite of this we saw sterling hovering near an eight-month low against the dollar on Friday as well as heading for its worst week since August on a trade-weighted basis, on bets the Bank of England is in no rush to follow the U.S. Federal Reserve with an interest rate rise. Though the BoE is expected to be the second major central bank to raise rates since the financial crisis, investors do not expect a move until late 2016, or even in 2017. Data this week showing inflation at zero and slowing wage growth will keep pressure off the Bank.