FX Daily Strategy: APAC, Oct 22nd

UK CPI expected to peak in September

EUR/GBP risks on the upside

JPY weakness may require explicit opposition from the new government to reverse it

CAD has scope to extend gains as BoC October rate cut not assured

UK Headline CPI to Nudge Higher Still, Core Stable?

Source: ONS, Continuum Economics

UK September CPI is the main European data on Wednesday. Despite adverse rounding and fuel (and food) costs, the headline stayed at 3.8% in the August figure, but we expect a rise this month to what we (and the BoE think) will be the inflation peak in September of 4.0%. This is also the market consensus. However, risks are on the downside, as we think food price inflation may slow, allowing a peak of 3.9% instead. We also see the core rate hitting a three-month low of 3.6%, slightly below the 3.7% consensus.

EUR/GBP has remained fairly steady for most of this month, trading an 0.8660-0.8720 range. We still see the risks as being on the upside, but it will require the data to show some further evidence of weakening in the inflation picture if the risks are to be realised. The labour market data earlier in the week were generally seen to be on the soft side, and if the CPI data come in in line with our forecasts, the risks are towards the upside for EUR/GBP. However, even if the data is on the soft side as we expect, it seems unlikely to be enough to trigger a sufficient decline in UK yields to push EUR/GBP above the year’s high at 0.8763. This remains a target, but it may require news from the November budget to trigger a move.

Otherwise, the weakness of the JPY remained a major feature of the market after Takaichi was appointed PM on Tuesday. She indicated that she hoped the BoJ would continue to pursue a 2% inflation target, driven by wage gains rather than commodity prices, which might be seen as a call for them to avoid tightening. An October hike remains only an outside chance, but further JPY weakness might pressure the BoJ to pull the trigger. However, it is unclear whether even tighter BoJ policy would prevent JPY weakness as the JPY has been weakening in the last few months despite yield spreads moving very much in its favour. There may also need to be a signal from the new administration that they don’t seek a weaker JPY to halt the downtrend.

The CAD managed a modest gain on Tuesday on the back of slightly stronger than expected September CPI data. However, there has been no significant decline in expectations of a BoC rate cut at the October 29 meeting in response, and this is still priced as around an 85% chance. We think it will be a close call, and slightly favour no change, which would suggests scope for USD/CAD to extend the decline below 1.40.