Weekly Brief

A big rate hike, followed by a bigger recession

05 August 2022

GBP

The bank of England (BoE) raised UK interest rates by 50bps to 1.75% yesterday. That represented the biggest single hike from the BoE since they were granted independence over UK monetary policy, back in May 1997. Whilst the move may had been widely expected, the commentary that followed it, clearly hadn’t. As well as revising their latest forecasts to reflect weaker UK growth, the BoE also projected inflation to peak at a whopping 13.3% by October of this year.

Aside from those inflation predictions, the biggest headlines came from the BoE’s expectation that the UK is likely to slip into a deep recession by the end of the year, lasting perhaps as long as 5 quarters, before a recovery. The BoE must be the only major central bank in the universe to be as candid as to hike interest rates by a substantial amount, at the same time projecting a deep-rooted recession. However, that is what the lay of the land is, as they say, and with those lofty inflation expectations, the BoE obviously considered it right to front-load on rates, just in case that looming recession creeps up a bit faster.

Andrew Bailey and the BoE have said that whilst the UK economy is suffering some unique circumstances from Brexit, there are cracks appearing in many economies right now. It is difficult to imagine other major central banks delivering their outlook in such an open manner.

The pound took the brunt of the market fallout from those BoE projections, and GBP/USD slipped from above 1.2200 to around 1.2065, before a decent pullback moved the pair back over 1.2150 by the European close. Honesty is the best policy, as they say. GBP/EUR followed suit, and slipped from around 1.1980 ahead of the BoE to 1.1850, before a sharp recovery towards 1.1900.

Next week is the turn of the latest growth figures from the UK, and having surprised to the upside last month (at 0.8%), there will be much attention paid to gauge the state of the economy, especially given the BoE’s rather sombre and downbeat outlook. 

EUR

It has been a fairly calm week for the single currency. After the fanfare around parity and the ECB’s rate hike recently, moves have been far more moderate. For example, EUR/USD has managed to remain above 1.0100, without being able to move above 1.0300 throughout this week (before Friday). As we said in the GBP section, GBP/EUR has been far more volatile, but the moves there were being impacted by sterling’s fortunes for the most part.

On the data front, Retail Sales for the region marked a sharp downturn of 3.7% through June, reflecting weak consumer demand, in part impacted by those bulging energy costs. Some slightly better PMI readings partially helped to offset, with the S&P Global Composite for the region nearly moving back over 50, at 49.9.

After some particularly weak data of late, the latest German inflation reading next week will be closely monitored. After tipping the scales at 8.5% last time round, harmonised CPI (YoY/Jul) may decline to around 8.2%. That would be a welcome boost, if achieved, and will likely dictate the short-term direction for the single currency. Sometimes no news is good news. 

USD

Markets have been on a positive run for a while now, with risk assets driving higher. The backdrop of softening economic data, resulting in what might become less rate hikes from the Fed going forward, has been a big ingredient to the positive sentiment. Quite whether the Fed are able to deliver the soft landing that markets are craving for, or whether there is a much deeper recession, will be left for another day. In the meantime, the bad news equals good news theory continues.

It has not all been doom and gloom on the data front this week, however, with the latest ISM Services PMI unexpectedly moving up from 55.3 to 56.7 throughout July. Markets had been expecting a drop to around 53.5. A little earlier in the week, the latest ISM Manufacturing Prices Paid index dropped heavily from 78.5 to 60. That is normally a good indicator of weaker inflation in 4-6 months, which would be a most welcome leading indicator, if that is the case.

Today is key for the U.S and the greenback. The July labor report is due, and the labor market has remained remarkably resilient throughout. Markets are expecting a 250k gain on the headline, which would represent a sight reduction from last month’s 372k gains. The overall unemployment rate is expected to remain at or around 3.6%. As always, other factors such as the participation rate, and average hourly earnings, as well as any major revisions to last month’s data will matter too.

Next week is the turn of U.S inflation, and the latest estimates point toward another bump higher in the Ex-Food and Energy (YoY) figure from 5.9% to around 6.1%. There may be some slight relief on the monthly print, which could drop from around 0.7% to 0.5%. The main CPI Index could also show some worthwhile improvements from last month, and would go some way to further boosting market sentiment.

As for the dollar, well the consolidation has mostly continued, with a few bumps along the way. The dollar index remains close to 105.00, which is still way down from its peak up at 109.00. 

CAD

Up until this morning (Friday) USD/CAD has maintained one of the tightest ranges throughout this week that there has been for a while. The pair only briefly managed to move below 1.2800, and the topside has been contained to well below 1.2900. Of course, that tight range is unlikely to hold through today, as the latest U.S and Canadian labor reports are due.

After a surprising drop on the headline last month (at -43.2k), markets are expecting around 20k in new jobs. The unemployment rate may drift up from 4.9% to 5%. A strong report will go some way to cementing the perception that the Canadian economy remains robust, and is able to withstand further rate hikes from the BOC.

As for the Loonie, well that tight range in USD/CAD has been impressive, given that oil has drifted lower, despite OPEC agreeing what looks to have been the smallest possible daily increase in production. The broader Loonie has been a slightly more mixed bag. GBP/CAD moved over 1.5800 earlier in the week, but fell victim of the BoE, and slipped back to 1.5600 by the close of play yesterday.

AUD & NZD

As expected, the RBA hiked Australian interest rates by 50bps to 1.85% this week. The RBA have now hiked rates for four months in a row. However, the RBA hike was accompanied with a somewhat dovish tilt, with Philip Lowe (RBA governor) suggesting that the economy would likely grow at a slower pace when compared against the RBA’s forecasts back in May. As one might expect, Lowe cited surging inflation for the hike.

AUD/USD was unable to sustain the pre-RBA gains at over 0.7000, and was probably most impacted by the dovish comments from Lowe. Despite this, the weaker greenback has ensured that the losses have been somewhat limited and the pair has bounced back after briefly moving below 0.6900.

NZD/USD has followed a similar path, and having rallied over 0.6350, briefly lost its way before bouncing higher by the end of the week. On the data front, there was a slightly worse than expected Unemployment report (Q2), with the Unemployment rate drifting back up to 3.3% from 3.2% previously.

 

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