Banking it – Where are we after the May Central Bank deluge?

What a week and a half we have had – Central Banks the world over have delivered their May decisions for their respective interest rate moves (or non-moves). 

Thus, we need to review the FX reactions and the outlook for rates for the rest of 2024.

Let’s start at home:

RBA and the AUD

First, as expected the Reserve Bank of Australia (RBA) left rates on hold at 4.35%, this was expected however the prospect of rate cuts in 2024 is fading fast. That was brought to light in the statement and Michele Bullock’s press conference.

Here’s a breakdown of the key points:

• Inflation Dynamics: The RBA notes that inflation is declining, albeit at a slower pace than expected. Services inflation is moderating gradually, driven by a labour market that the RBA now perceives as tighter than previously assessed. This indicates that the labour market conditions are exerting influence on inflation dynamics.
• Monetary Policy: The RBA views its current monetary policy stance as restrictive, with the cash rate level seen as supportive of achieving the target inflation range of 2–3%. However the Board did leave the door open for all movements both hikes and cuts if inflation doesn’t return target inside a meaningful timeframe.
• Other Considerations: The RBA remains attentive to developments in the global and domestic economy, the outlook for inflation and the labour market. Thus, it remains data-dependent to policy decisions.

What caught our attention the most was the shift in language, particularity the downplaying of supply-side inflation and the attention on domestic demand which is still be too high leading to the same sticky inflation effect we are seeing in the US .

The FX market reaction was mixed on all this, the initial reaction was bearish as the more hawkish bets of the previous few weeks unwound. However, the AUD remains one of the best performing currencies in the G10. With the RBA signalling that its next move may still be a hike it is likely to remain in the ascendancy against those FX players that are facing confirmed cuts in the coming months.

BoE and GBP

It seems like the Bank of England (BoE) is navigating through some interesting waters with its monetary policy decisions. The Board voted 7-2 vote to keep rates at 5.25%, but it was Governor Andrew Bailey’s remarks post the decisions that caught the market’s attention hinting at a potential shift towards a sharper and faster accommodative stance. 

The fact that money markets are fully pricing in a rate cut by August, with a considerable probability assigned to a cut in June (44%), indicates a significant anticipation of policy easing. But Bailey’s suggestion suggests it could be sooner and stronger than priced.

No doubt the BoE’s decision-making will indeed be influenced by upcoming data on wage settlements and inflation. But it’s clear the impact on the GBP is one way and that is down, particularly when it’s against the likes of the USD or AUD. It’s a slight more mixed position against the EUR, SEK and CAD as their respective banks are also pointing to rate cuts.

ECB and the EUR

The EUR is facing a mixed bag having eased through the year but is facing a complex interplay between economic data, market sentiment, and central bank expectations. 

For example despite some mixed German economic indicators, EUR managed to strengthen last week supported by positive developments in German exports and stronger Eurozone retail sales.

The real headwind for the EUR is the speculation of when (not if) European Central Bank (ECB) will rate cuts. Speculation is rising that next month’s meeting will be the start point after the minutes from the last meeting reinforced dovish bets.

Something to watch, the upcoming release of May’s ZEW economic sentiment index for Germany could provide further insight into the economic outlook. If the sentiment continues to improve, particularly in the Eurozone’s largest economy, it could lend support to the EUR amid ongoing uncertainties surrounding ECB policy decisions. Watch the likes of EURGBP and EURSEK in particular.

Riksbank and SEK

And finally, a mover. For the first time in 8 years the Riksbank lowered its key interest rate to 3.75% after a two-year period of rate hikes. 

Governor Erik Thedeen’s indication that two more rate cuts are likely in the second half of the year, contingent upon inflation remaining subdued, reflects the proactive stance aimed at supporting economic stability from the Bank.

However, Thedeen’s emphasized caution as the economic landscape and potential risks associated with policy changes could change the Bank’s outlook. This could explain the reaction of the SEK to the rate cut a short-lived weakening then a recovery. This highlights the interplay between monetary policy as bigger players such as the BoE and ECB could overrun the dovishness in the smaller SEK for the bigger EUR and GBP.