Worries have helped the dollar continue to rise, Bank of England interest rate hikes are expected and the economic outlook improves, and the pound is expected to stabilize and rebound

On May 15, Beijing time, the Asian market morning, the U.S. dollar index rose slightly by 0.02%, and is currently trading around 102.74. On Friday, the U.S. dollar index was 0.61% at 102.70, and the weekly gain was 1.4%, the largest weekly gain since February. Investors turned to the safe-haven dollar after consumer confidence data heightened concerns about the U.S. debt ceiling and monetary policy.

US consumer confidence slipped to a six-month low in May amid concerns that a political battle over raising the federal government's borrowing limit could trigger a recession, according to a University of Michigan survey released on Friday. Consumers' long-term inflation expectations jumped this month to their highest level since 2011, bad news for the Federal Reserve, which last week signalled it might pause its fastest monetary tightening cycle since the 1980s.

"Interest rate differentials continue to give the dollar an advantage," said Karl Schamotta, chief market strategist at Corpay. "The surprise in the University of Michigan consumer sentiment survey paints a stagflationary picture for the US economy, which may justify another Fed rate hike at its June meeting, but will certainly reduce the chances of a rate cut in the second half of the year."

Recent data showing an economic slowdown has given the Federal Reserve reason to pause interest rate hikes at its June meeting. Earlier data showed that the US consumer price index (CPI) fell to 4.9% year-on-year in April. And initial jobless claims rose more than expected last week. But the labor market remains tight, with 1.6 job openings per unemployed person in March, well above the 1.0-1 range, a level at which the job market will not be without generating too much inflation.

Bowman, the governor of the Federal Reserve, said that if inflation remains high, the Federal Reserve may need to raise interest rates further.

Joe Manimbo, senior market analyst at Convera, wrote: "The dollar's rally last week was driven by multiple factors. The dollar has become a safe haven amid concerns about economic weakness in Asia and volatility on Wall Street. Although it has strengthened, it is too early to tell whether the dollar's weakness has reversed. The market needs to withdraw interest rate cuts to give the dollar meaningful upside."

Futures traders expect the Federal Reserve to pause interest rate hikes in June and lower rates later this year. The Fed's current benchmark interest rate range is 5% to 5.25%, which has risen rapidly from near zero levels in March 2022.

The euro closed down 0.6% against the dollar on Friday at 1.0849.

Joe Manimbo, senior market analyst at Convera, pointed out that the still-high level of U.S. inflation has raised some doubts about the Federal Reserve's end-of-year interest rate cut, and the view that other central banks may also be closer to pausing interest rate hikes has also weighed on European currencies.

The ECB appears to be expected to continue raising interest rates for longer than the Fed, but with the eurozone's growth outlook weak: private consumption remains below pre-pandemic real levels, industrial production is shrinking, and demand for new loans is in unprecedented decline, future rate hikes in the euro zone may be limited. And it will be difficult for the ECB to continue raising interest rates in the face of a US recession and rate cuts.

The pound closed 0.51 per cent lower at 1.2447 against the dollar on Friday. The Bank of England raised interest rates on May 11 in a hawkish manner, but the economic outlook remains weak, weighing on the pound. However, market expectations that the Bank of England will continue to raise interest rates in the future are expected to boost the pound.

The UK's GDP in the first quarter was in line with expectations, and the Bank of England revised its economic and inflation forecasts. The UK's GDP in the first quarter announced on May 12 was 0.2% year-on-year and 0.1% month-on-month, which was basically in line with market expectations. Although the recovery of household consumption slowed down, government consumption decreased, inventories decreased, and the trade deficit remained large, the latest data show that in 2023, as natural gas prices fell, the UK's trade deficit has begun to narrow, and the job market is still relatively healthy. The risk of a recession in the UK has eased.

At the monetary policy meeting in May, the Bank of England decided to raise interest rates by 25 basis points to 4.5%. At the same time, according to the improvement of energy prices and the resilience of the global economy, the Bank of England revised its economic forecast significantly. It is expected that real GDP will grow by 0.25% in 2023 (February forecast - 0.5%), but the CPI inflation forecast is also revised sharply. 23Q4 will only fall back to 5.1%, and it is expected to fall back to 2% in 2025.

Traders are betting that the Bank of England will tighten another 42 basis points by September. MUFG maintained its bullish view on sterling following last Thursday's resolution. We have passed the "peak of pessimism" towards the UK and a reversal in energy shocks will help provide macro resilience as inflation falls, they wrote in a note. Sterling could break through 1.3000 against the dollar. EUR/GBP also fell below lows, but the pound has less room to rise against the euro.

Goldman Sachs believes that the Bank of England's policy stance is no longer an outlier in the G10, and the previous negative impact on the pound has turned positive. Goldman Sachs recently argued that the headwinds facing the pound in 2022 (mainly gas and energy prices, Brexit-related frictions, and the relative stance of the Bank of England's policy) have now shifted in a less negative direction.

Goldman Sachs predicted that the Bank of England may raise interest rates by another 25 basis points in June and August, reaching an end point of 5% (above current market pricing), and advised investors to go long the pound against the euro.

Danske Bank economist BjornTangaaSillemann: It is expected that the Bank of England will raise interest rates by another 25 basis points in June, bringing bank interest rates to a peak of 4.75%; another interest rate hike in June may finally ensure that the pound can still be supported in the short term.

Key data and events on Monday

Institutional Perspectives Summary

1. Mitsubishi UFJ: The dollar is expected to gain more support.

Mitsubishi UFJ said that recent developments are undermining market optimism about economic growth prospects outside the United States, which could help provide more support for the dollar.

Mitsubishi UFJ said it needs more convincing economic data in the coming months to prove that the U.S. economy is slowing sharply/falling into recession in order to strengthen expectations for further interest rate cuts in the future

2. Societe Generale: The feeling that the dollar is overvalued will not be easily thrown off;

① Kit Juckes, chief global FX strategist at Socie ́ te ́ Ge ́ ne ́ rale, says the dollar is doing okay during the day, but its valuation is not. A rebound in the yen is just a matter of waiting for the Bank of Japan to act. Neither the current state of the global economy nor global geopolitics is enough to justify holding on to most of the dollar's gains in 2021-2022;

② On a day-to-day basis, positions, yield movements, geopolitical uncertainty and economic data trends all suggest that the dollar is likely to stay in a narrow range for some time. But the feeling that the dollar is overvalued is not easy to shake off. And so is the feeling that the yen rebound is just a matter of waiting for the Bank of Japan to act

3. Deutsche Bank: The direction of the pound will depend on the next inflation data.

① You-NaPark-Heger, a foreign exchange analyst at Deutsche Bank, said in a report that the UK inflation data to be released on May 24 will play a decisive role in the Bank of England's next interest rate decision, thus affecting the direction of the pound.

② He said: "If, as the BoE expects, inflation falls sharply from now on, it may not raise rates further, which will put pressure on sterling. However, the risk that the BoE will do more has certainly increased since yesterday."

The Bank of England raised its key interest rate by 25 basis points to 4.5 percent in May and said its next decision on June 22 would depend on data

4. Royal Bank of Canada: I don't think the dollar will continue to decline.

Adam Cole, chief foreign exchange strategist at RBC Capital Markets, said he disagreed with the mainstream market view that the dollar could continue to decline, and he did not think the dollar's decline was a sustainable trend.