ECB may tweak the pace of PEPP purchases as focus remains on spread control

GBP

Sterling continues to float higher as broad dollar weakness drifts back into play for markets. The renewed risk appetite isn't just buoyed by expectations of additional fiscal stimulus, but a stabilisation of virus conditions in most major economies. Thus far, it seems as if draconian lockdown measures are helping to stabilise and reduce the number of cases, which is supporting the pro-cyclical backdrop in markets as well. For sterling, its 0.78% rally week-to-date against the dollar is largely due to this supported risk environment in lieu of any market moving data points. More interestingly, sterling's half a percentage point rally against the euro this week has dragged GBPEUR up to levels not seen since May 2020. The divergence in sterling and the euro can largely be attributed to the differing levels of vaccine distribution. The UK is a relative success case in this light, which is being reflected in currency markets. Yesterday, Bank of England Governor Andrew Bailey stated that the economy is learning to better adapt to lockdown measures when speaking in a webinar. Bailey said the Bank has little evidence on January's economic performance thus far but said: 'probably the impact of lockdowns in economic terms is diminishing somewhat. We all find ways to do economic activity by adapting. Online shopping is the obvious best example'. This was something that was visible in November's GDP which was released last week, where the economy performed two percentage points better than expected despite the UK economy subject to national lockdown measures. Today, sterling's focus will likely be on events in the eurozone and what the ECB's meeting means for GBPEUR, while the CBI reports business optimism data for January at 11:00 GMT.

EUR

The euro broadly sold off in the G10 space throughout yesterday's session as expectations of a bleak eurozone economic outlook was weighing on the currency. The ongoing criticism over the euro area's lagging immunisation rates relative to the UK and US following a slower vaccine rollout, combined with the delay in the Pfizer shipments to Europe does not bode well for the eurozone outlook in the very short term. Pfizer confirmed however that there would be a significant increase in doses available for patients in late February and March, leaving the medium- and longer-term outlook unchanged. The depreciation of the euro may come in handy for the European Central Bank today, as the exchange rate has been receiving more attention by both markets and ECB policymakers recently. The ECB will likely not make any adjustments to its monetary policy today, despite the deteriorating virus situation and recently extended and tightened lockdown measures weighing on the short term outlook since the December policy decision. If the ECB would really put in all its chips, the central bank may tweak the Pandemic QE (PEPP) purchases such that the short term purchases would be moderately increased while not adjusting the overall size of the envelope. Either way, today's meeting will likely hold no fireworks and markets will focus on any emphasis on the downside risks to the latest forecasts, while President Christine Lagarde should also expect to receive questions on the appreciation of the bloc's currency. The press statement will be released at 12:45 GMT, after which a press conference will follow at 13:30 GMT.

USD

The dollar weakened against most G10 currencies yesterday, with the exception of the euro and the Swiss franc as the news cycle focused on President Biden's inauguration in Washington. Markets enjoyed the transition of power, with US equities sitting in the green. Both the DJIA and NASDAQ indices touched record highs in yesterday's session, while risk sentiment was also well supported in FX markets. With the formalities out of the way now, markets will keep a keen eye on the progression of fiscal stimulus efforts in Washington as President Biden hit the ground running yesterday, reversing decisions by Donald Trump to place the US back into the WHO and Paris Accord, while revoking the permit for the $9bn Keystone XL project. Meanwhile, a hearing on Janet Yellen's Treasury Secretary nomination is expected tomorrow after she testified on Tuesday. Jobless claims data released at 13:30 GMT today may be another case of 'bad news is good news' for markets. Initial jobless claims are expected to rise by 935,000 in the week of January 16th, leading to the continuing claims number rising to 5.3m. A continuing deterioration in the US labour market strengthens the case for more aggressive fiscal stimulus to be passed swiftly via bipartisan agreement in the Senate - a dynamic markets are more than aware of.

CAD

The loonie touched a fresh 33-month high after yesterday's Bank of Canada meeting saw Governor Tiff Macklem reject calls for a mini rate cut and instead strike a mildly optimistic tone. The Bank of Canada's forecast revisions did most of the signalling to markets yesterday after the rate statement saw no changes in policy despite OIS markets implying a 10bps cut could have been on the horizon. The BoC downgraded its 2021 growth projection from 4.2% to 4.0%, owing to the lockdown measures in place at present, but upgraded 2022's growth forecast from 3.7% to 4.8%. The forecast revision coupled with the lack of monetary easing gave markets the green light to sell the Canadian 2-year, thus increasing its yield, unwind expectations of mini rate cuts in OIS markets and buy the loonie. Governor Macklem did little to stand in the Canadian dollar's way in the press conference, despite being questioned on CAD appreciation in the Q&A. In response, the Governor repeated messages the Bank has already relayed; that a stronger Canadian dollar is a headwind to exports but is driven by broad USD dynamics and not Canadian factors. From the meeting, we now expect the overnight rate to remain at 0.25% unless conditions deteriorate substantially, with the Bank tapering its QE programme towards the back end of the year. This should provide the loonie with additional tailwinds as our expectations for BoC normalisation precedes that of the Federal Reserve. Short-term headwinds remain in play for CAD though, especially with the current lockdown measures expected to stay in place for some time. The BoC conditioned its forecasts that most aggressive containment measures will remain until mid-February. Additionally, Canada's oil market took a knock yesterday as President Biden revoked the Keystone XL project's permit. However, Western Canada Select prices have arguably priced this in already, with the price falling nearly $4 this week alone.

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