Market sentiment weakens, risks remain

[UK expected to face 'shallow but prolonged' recession]

Britain is facing a lengthy recession as high inflation and rising interest rates will continue to squeeze incomes throughout 2023. The U.K. recession will be "slight but long-lasting," with U.K. GDP expected to shrink by 1.3% in 2023. The economy may recover only partially through 2024, when it is expected to grow by 0.2%. Higher energy and food prices through 2022, as well as higher headline inflation, have significantly reduced household purchasing power. And rising interest rates have created another headwind for economic growth. Households are expected to rein in spending on non-essential items in 2023 in response to the income crunch.

[European energy ministers reach emergency gas price ceiling deal]

European energy ministers have reached an agreement to impose emergency limits on gas prices. Ministers agreed to set a cap of 180 euros per megawatt-hour for gas prices in the EU's main trading hub for the next month, compared with a proposal of 275 euros per megawatt-hour in an October proposal, the people said. Restrictions will only come into effect under certain conditions. Traders, exchange operators and others say imposing price caps could be troublesome. If the EU pursues the policy, it could shift its gas market outside the bloc, adding that the plan does not give enough time to implement the cap in a way that does not destabilize the market.

[New BOJ considers governor revising a monetary policy]

Japan is considering revising a key monetary policy after the appointment of a new Bank of Japan governor in April. The government will consider revising a joint statement it signed in 2013 pledging the BOJ will achieve its 2 percent inflation target as soon as possible. This may provide timely flexibility, but it does not constrain the bias of monetary policy in any way, and more details are needed to have a larger impact on the yen.

[The next three meetings will be held on hold]

The Bank of Japan is expected to keep its accommodative stance unchanged again at its upcoming meeting, but any shift in tone that lays the groundwork for an eventual rate hike will come under scrutiny. Markets are currently not pricing in any interest rate changes until April 2023, although views remain largely divided on whether a 0.10% hike or a larger 0.20% is necessary. But for now, it looks likely that no change will continue for the next three meetings. As such, any talk of tweaking the yield curve control policy and any sign of a departure from its ultra-dovish tone will be watched at the upcoming meeting as it reflects a policy shift ahead. Any hawkish surprise could trigger a reflexive rise in the yen.

[If the euro strengthens, the pound may become the main victim]

The ECB clearly wants a stronger euro to help it fight inflation. If the ECB is to succeed in pushing the euro higher, the euro will need to bounce back against currencies that have major weights in the trade-weighted euro index. The largest weights in the index are the U.S. dollar (16%), Chinese yuan (14%) and British pound (12%). Of the three, sterling is the most vulnerable as the Bank of England is closer to ending its tightening cycle than the Fed and the UK's large current account deficit makes it vulnerable to a global economic slowdown. Doubt that EUR/GBP will have good demand below 0.87.

[The market still expects the Fed to eventually raise interest rates by 50 basis points in early 2023]

The market still expects the Fed to eventually raise rates by 50 basis points in early 2023, but no rate cuts until 2024, and the dollar will weaken during 2023; Part of the reason for the further decline in the dollar. The 'safe-haven' dollar could weaken further if slowing U.S. inflation allows the Fed to soften its hawkish stance further and global growth avoids a severe slowdown. The FOMC will eventually raise the policy rate by 50 basis points in February 2023, while acknowledging upside risks. The FOMC expects to cut rates by 50 basis points in 2024 (25 basis points in the second quarter of 2024 and 25 basis points in the third quarter of 2024), bringing the fed funds target range back to 4.25-4.50% by the end of 2024.