Yesterday saw European markets endure another rollercoaster session as investors mulled the prospect of an imminent stimulus announcement from the ECB at next week’s rate meeting as the market Frankfurt rumour mill went into overdrive, against the prospect of increased deflationary pressures as Brent oil prices embarked on fresh leg lower, as the imminent likelihood of an OPEC production cut appeared to be further away than ever.
US markets also endured a similarly volatile session yesterday, following oil prices to close lower as attention shifts towards the start of Q4 earnings season, and it is this weakness that looks set to weigh on the European open this morning.
This continued decline in prices is likely to be in focus today with the latest inflation numbers from the UK, as well as the latest trading updates from retailers, like WM Morrison(Wm.)Supermarkets (LONDON:MRW), Debenhams Plc (LONDON:DEB) and Asos (LONDON:ASOS).
Heavy discounting from retailers like these, as well as falling oil prices look set to see another decline in UK prices for December, a stark contrast to a year ago.
For most of last year investors had been pinning their expectations on the timing and prospect of an interest rate rise by the Bank of England, as the UK economy started to grow quite rapidly at the same time as unemployment started to fall sharply, along with the rate of inflation.
At one point a minority in the markets were even pricing in the prospect of a hike at the end of last year, helped in some respects by the bi-polar nature of some of the announcements of some MPC policymakers, in particular Governor Mark Carney himself.
Whether this was a deliberate policy to keep the markets off balance and introduce an element of two way pricing, only Bank of England policymakers will know, but the ambiguity surrounding some of the banks announcements prompted some unflattering comparisons to “unreliable boyfriends” as well as some tetchy exchanges at Bank of England press gatherings.
Since the end of last year the debate has shifted somewhat with the prospect of rate hikes now being slowly pushed out well beyond the General Election date later this year.
Today’s UK inflation numbers are unlikely to shift the debate that much, and could even start to shift timing expectations well into next year, especially if the recent falls in oil price push the year on year target below 1% for the first time since June 2002, when we got a reading of 0.6%.
Expectations are for the annualised rate to slip below November’s 1% and come in at 0.7% for December, with the drop in energy and food prices expected to account for a large part of any drop.
If we get such a fall, and the latest EU CPI numbers would suggest that we will then we could well see rate rise expectations pushed out even further, particularly if wage growth continues to remain weak. The fact is UK average earnings growth still remains on the low side at 1.4% and after stripping out energy prices, core prices are still set to remain well above 1%, with an expectation of a slight rise to 1.3% for December.
This highlights an unusually disproportionate gap and serves to reinforce the effect the sudden drop in oil prices has had on the inflation outlook, which in the past, central bankers in general have tended to look through.
Currently the gap between core prices and headline prices in Europe sits at 1%, while the gap in the UK is set to widen to 0.7%.
The last time we saw core prices in the UK come in below headline prices was in 2009, just after the previous oil price slump and the behaviour of prices back then could well give us clues as to what could well happen next.
When the fall in energy prices pushed headline inflation below core prices in mid-2009 no-one on the MPC even considered the prospect of higher rates, they were actually doing the opposite with a QE program, so it would be extremely counterintuitive indeed if we got a consensus to increase rates now.
Furthermore if we use the previous oil price crash as a comparison it took ten months after oil prices bottomed out at the end of 2008, for inflation in the UK to bottom out and start rising again month after month, which would seem to suggest that we could well see the headline rate slip into negative territory before this year is out, and then the discussion could well shift to a discussion about more stimulus.
Given current momentum on commodity prices now, the fear remains that we may well not have hit bottom yet on oil or food prices which suggests, given the time lag effect, with prices already low, it won’t take that much more to push us to or below zero and outright deflation.
EURUSD – while we manage to remain above the recent lows near 1.1750 the prospect of a short squeeze can’t be ruled out. The bullish daily candle on Friday could well see a move back towards 1.1975 initially and a move back towards the 1.2000 level. The main resistance sits at the 200 month MA at 1.2240. A move below 1.1750 targets 1.1600.
GBPUSD - Friday's pull back and the failure to sustain a move below 1.5100 could well see a rebound towards 1.5320. We do need to overcome initial intraday resistance at 1.5180 first. The daily candle formation of the last two days suggests the potential for a short squeeze. Intraday support remains at last week's low at 1.5035 and the 1.4980 level.
EURGBP - currently range trading between 0.7800 and resistance at 0.7870 with the key reversal day last week suggesting the possibility of a move towards 0.7930. Below 0.7800 retargets the six year low at 0.7744 last week.
USDJPY - continues to find resistance near the 120 area with further resistance at the 120.80 level. The US dollar appears to be stuck in a range and could well drift back towards the 115.60 level. A move back below 117.80 argues for just such a move.
Equity market calls
FTSE100 is expected to open 16 points lower at 6,485
DAX is expected to open unchanged at 9,781
CAC40 is expected to open 5 points lower at 4,223
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