Currency markets have remained in the peaceful slumber they started the week in, with the majors’ content to consolidate after Friday’s outsized moves left many participants out of breath. The overnight Asian session displayed some volatility, with the Shanghai Composite initially sliding on the follow-through from the pessimistic close on Wall Street that saw the S&P edge lower by 1%; however, the Shanghai Composite was able to rally back into the latter portion of its session, after inflation data from the region dropped faster than had been expected. The reading of consumer prices in China dived by 0.3% on a month-over-month basis, pushing the annualized reading to only a 1.3% increase when compared to the last twelve months, a collapse from the 1.6% pace registered in September, and lower than the 1.5% analysts had expected. With the softening of consumer prices, and notable deterioration in food stuffs, this affords the People’s Bank of China with confidence they can do more to loosen monetary policy without the threat of stoking already lofty inflation data, and although we would suggest today’s CPI data increases the probability of an additional interest rate or reserve requirement cut from the PBoC, if Retail Sales and Industrial Production come in below estimates overnight, that will solidify expectations of actions from the PBoC to boost economic activity.
While the pound has seen muted price action against the greenback this morning, we don’t expect this to last for much longer, as employment data set to be released tomorrow will likely spark two-way volatility in the pair. With the recent dovish bias of the Bank of England that has pushed interest rate hike expectations out until late-2016/early-2017, combined with the stellar employment data from the US all but solidifying a rate hike before the end of the year, the pound has been punished, and continues to trade with a heavy tone. Like the euro, the divergence meme has placed the bias to the downside for GBPUSD, though we would caution the pair would be susceptible to a short covering rally should earnings growth and the unemployment rate improve. Market participants would be wise to pay particular attention to 3-month moving average of earnings growth, as this indicator has been on the upswing and is forecast to show continued improvement with a reading north of 3.0%. The basis for this attention would be the assumption that tightening labour market conditions that put upward pressure on wages will start to filter through to the economy and have a positive flow-through effect on overall inflation, which the Bank of England just downgraded in their last inflation report. There are a number of practical factors that challenges a direct relationship between wage growth and inflation, yet the larger risk for the pound given the recent price action is to the upside, as the weaker shorts will likely run for cover if the employment report is brighter than anticipated.
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