Sterling on the front foot

Sterling outperformed last week as stronger than expected UK economic data and hawkish Bank of England commentary prompted a paring back of market expectations for interest rates cuts next year and an associated spike in bond yields. The pound gained about 1.5 cents against the dollar and almost a penny against the euro, kicking off this week trading at $1.261 and 86.7p respectively. The euro was confined to a narrow range against the dollar last week, albeit ending marginally firmer overall, and is trading at about $1.0950 at the start of play today.

UK government 2- and 10 year yields  jumped by 15-20bps last week, ahead of the increase in equivalent US and German yields which rose by around 5-10bps, while UK equity markets underperformed, ending marginally lower on the week in contrast to gains of almost 1% for both US and European stocks.

With the ECB’s mid-December monetary policy meeting coming into view, President Christine Lagarde says it has “already done a lot” in terms of raising interest rates and so can now “observe” the impact its tightening to date is having on the economy and inflation – pointing to no change in rates again next month.

The US economy expanded marginally again in November judging by the flash PMIs published on Friday, with the Composite index rising slightly to 50.7 this month from 50.4 in October. Significantly though, “relatively subdued demand conditions” are reported to have prompted firms to “cut their workforce numbers for the first time since June 2020.”

The focus this week will be on Thursday’s inflation data in the Euro area and the US. According to the consensus forecast, the flash readings for November in the Euro area are expected to show both headline and core CPI inflation nudging down further this month to 2.7% and 3.9% respectively (from 2.9% and 4.2% in October), while in the US, headline and core PCE inflation  – the Fed’s target measure of inflation – are seen falling to 3.1% and 3.5% in October (from 3.4% and 3.7% in September). Outcomes along these lines will cement market expectations that the ECB and Fed are done hiking interest rates and will be easing policy next year.