Week ahead: US inflation and BOE rate decision on the menu

Another pivotal week lies ahead for forex traders, with the latest US inflation report expected to decide whether the relentless rally in the dollar will finally subside. Meanwhile, markets are tilting towards a half-point rate hike from the Bank of England, although the fate of the pound sterling is mostly in the hands of global forces.
Inflation Cooldown
It’s been a great year for the US dollar so far. Reserve currency is essentially the only asset that has gained ground over the past nine months, riding a perfect wave of widening interest rate differentials, inflows of safe havens and a lack of alternatives.
The Fed recently poured gas on this rally when President Powell pledged to do whatever it takes to stamp out inflation, even if it means a tough economic time. He reinforced the idea that interest rates will have to be kept high for some time, sending traders rushing to set prices on a “higher for longer” path.

Encouraged by a labor market that is essentially at full employment, the Fed chief is confident that the economy can absorb this blow without sliding into a deep recession. Markets are currently pricing in an 85% chance of another three-quarter point rise this month and a terminal rate of just under 4% to be reached early next year.
Naturally, future data will be a crucial piece of this puzzle. The CPI Inflation report for August is released on Tuesday and the forecast points to a negative monthly print, which would also lead to a lower annual rate. Gasoline prices continued to fall during the month and S&P Global’s business surveys suggest that service companies raised their selling prices at the slowest rate in a year and a half.adding credibility to the forecast.
A second straight month of easing price pressures would be music to Fed officials’ ears, but it wouldn’t be enough to get them off their warpath. The Fed’s second-in-command, Lael Brainard, said this week that it would take “several” months of low inflation readings before they become confident that inflation is falling toward its 2% target.

As for the dollar, even a disappointing inflation impression is unlikely to change the overall trend. Markets could start to flirt with a half-point Fed hike this month and that could hurt the greenback, but it’s hard to see a reversal as Europe suffers from supply shortages. energy, that the yen is in free fall and that the real estate crisis in China is deepening.
Retail sales for August will follow on Thursday, ahead of the latest consumer survey from the University of Michigan on Friday, which recently turned into an emotional market release.
BoE – double or triple?
In the UK, the Bank of England will announce its rate decision on Thursday. Market prices are tilting toward a half-point rate hike, assigning a 65% probability to this scenario versus a 35% probability for a larger three-quarters percent move.
It’s a tough choice for the BoE. Business surveys point to an economy already contracting as demand slumps under the weight of the cost of living crisis. Alongside the government’s plan to cap energy prices, which will likely keep inflation from hitting the 13% peak envisioned by the BoE in its latest forecast, there are strong reasons policymakers should play caution and opt for the smallest movement.

The problem is the exchange rate. The British pound has already depreciated dramatically, second only to the Japanese yen’s collapse this year. Opting for half measures would invite further weakness, exacerbating inflationary pressures.
There is a deluge of data releases ahead of the rate decision that will help shape market expectations. The show will begin on Monday with GDP statistics for July, ahead of the jobs report for the same month on Tuesday, and the latest inflation data on Wednesday. Then on Friday the retail sales for August should come out.
As for the British pound, the most important variable will not be the BoE’s firepower next week, but rather what will happen with the stock markets. Due to the UK’s chronic twin deficits, the pound has developed huge sensitivity to global risk sentiment, with Cable trading in line with the S&P 500 most of the time.

In this regard, the outlook for equities remains challenging. The Fed is determined to keep rates high until inflation is defeated, the pace of quantitative tightening has doubled in the past week, valuations are still not cheap and a series of earnings cuts could be imminent if Europe and China keep rolling.
A look at China
Finally, China’s monthly data dump which includes retail sales and industrial production will be released on Friday. Investors will be keen to assess the damage wrought by a plummeting real estate sector and recent lockdowns in major cities.

Ahead of this data set, the latest Australian employment numbers and New Zealand’s second-quarter GDP will hit markets on Thursday. While both of these economies are domestically strong, it’s hard to be bullish on their currencies given their high exposure to China.
With China’s struggling economy, demand for commodities that Australia and New Zealand export will inevitably take a hit, which paints a bleak picture for growth.

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