Weekly Brief

The ECB settle on a 25bps hike in July

GBP

There has been much negativity surrounding the UK recently. On the political front, there has been that vote of no confidence in PM Johnson from his own party. He may have won, but the closeness of the vote, with a whopping 41% of his own party voting against him, will make it challenging for the PM to push forward his agenda effectively.

The distraction for him and the government comes at a difficult time, with inflation in the UK currently ranking amongst the highest in the developed world, and real income growth lagging too far behind. The cost-of-living increases are therefore accelerating rapidly, and are likely to get worse before they get any better, as the energy price cap gets raised again later in the year.

In a report published just this week, the OECD think that the UK will be 19th placed for growth next year amongst the G20 group of nations, only outpacing Russia’s growth. Therefore, the chances of a technical recession, which is generally considered two consecutive quarters of negative growth, look very high.

Moreover, the BoE look likely to raise rates again in the UK next week, as they try to impact the surging inflation. Of course, that just puts even more pressure on the pockets of the poorest in the UK, who rely on credit cards and high-interest borrowing schemes to get by. In fairness to them, the government are working on schemes to try to help those who need it most, but those schemes should be targeted, specific and not general in nature.

In spite of all this, the pound has had a rangebound week, with GBP/USD maintaining a tight 1.2500-1.2600 range for the most part. GBP/EUR drifted back up to 1.1800 yesterday, but that was more about EUR weakness (see EUR).

EUR

The latest ECB meeting this week had been welcomed with almost fever-like anticipation by markets. Whilst most had agreed on what the ECB were likely to do this month (no rate hike, ending APP), there was much debate around what they might say about what they were likely to be doing in terms of the size and timing of future rate hikes. In the end, the ECB gave pretty good forward guidance, suggesting that they ‘intend to raise the key ECB interest rates by 25 bps at its July monetary policy meeting’.

September now becomes the interesting month, with the ECB adding that, if the inflation outlook is maintained or gets worse, ‘a larger increment will be appropriate at the September meeting’. The interesting bit there is that the ECB have flipped their narrative on its head, and effectively said that they will raise rates by 50bps in September, unless inflation markedly improves region-wide in the meantime. That gave the hawks something to smile about. Call that bit a hawkish surprise, if you like.

The day before that ECB had seen some surprisingly stronger growth figures for the region being released, with a 0.6% (QoQ/Q1) jump doubling expectations, as well as a decent improvement in employment. This had ensured that the single currency went into the ECB meeting on the ascendency, with EUR/USD probing 1.0750. Despite the hawkish surprise, those gains were short-lived, with the single currency slipping back in the immediate aftermath, most probably driven by disgruntled traders who had been hoping/looking for a 50bps hike in July.

Now that the ECB meeting is behind us, and with the next keynote data being HICP Inflation due out this time next week (Friday), the single currency is likely to be led by the dollar moves over the coming days (see USD).

USD

The greenback has been gradually appreciating this past week, without the moves generating too many headlines, bar that multi-year rally in USD/JPY perhaps. U.S macro data has been somewhat more positive at the margin, with that goldilocks employment report last week helping to convince markets that the Fed will not be deterred from their battle against inflation.

Talking of inflation (as we sometimes do), the latest CPI inflation is due out later today (Friday). There is much weighing on this report, in fact it really has been the biggest cloud hanging over markets all week. The hope here is that inflation will finally start to ease, with the key ex-food and energy components increasing a smidgeon less than last time round. On a monthly basis, the latest estimates expect a 0.5% rise, down from 0.6% last time round. The yearly figure should see a bigger drop from 6.2% to 5.9%.

If the analyst expectations are on the money, then it should give markets a boost, and help to cement the belief that the Fed can manage a soft landing for the economy. If inflation goes the other way and carries on rising, well that is unlikely to go down too well.

Beyond today, and markets will start to focus on the impending FOMC meeting next week. A 50bps hike is expected and fully priced in. A further 50bps hike is also expected next month. Much the same as the ECB (now), September becomes the interesting month. The Fed may be in a position to decrease the pace of hikes to 25bps by then, but to do that inflation needs to play ball, and that all starts today.

For the greenback, it will be guided on U.S data, and risk appetite. USD/JPY continues to take lions share of the headlines, given that at (or near) 134.00, represents a 20-year high. Interest rate differentials are clearly the biggest factor driving the dollar’s rally.

CAD

Having gradually drifted down to near 1.2500 earlier in the week, driven partially by surging oil prices, USD/CAD turned on its heels yesterday and rallied sharply back to 1.2700. Oil prices turning south played their part, but comments from BoC governor, Tiff Macklem, also impacted the Loonie.

When asked whether households could handle a larger than 50bps rate increase, he said that the bank needs to take a larger step. Furthermore, he said that the chances of (Canadian rates) going above 3% have risen, which implies that that the BoC would need either bigger, or more than expected, rate increases going forward.

Looking ahead, today’s Canadian employment figures (May) will be key to the broader Loonie, in spite of U.S inflation likely being the dominating factor to the direction of USD/CAD on the day. A 30k increase in the headline is expected, up from 15.3K last month, coupled with a steady unemployment rate of 5.2%.

AUD & NZD

That 50bps rate hike from the RBA this week caught markets by surprise. Indeed, when the announcement was made during the Asian session, it was enough to spark an asset-wide sell-off, as market participants fretted over why the RBA deemed it necessary to make such a bold hike now.

Ahead of the meeting, analysts had expected a 25bps hike from the RBA, but they deemed it necessary to move big now citing inflationary pressures, despite at 5%, inflation in Australia is running at much lower levels than that of much of the developed world.

Interestingly enough, AUD/USD has moved lower since the announcement, and having briefly rallied over 0.7250 on the news, has since slipped back to 0.7100. Looking ahead, next week’s Australian employment report will take centre stage, with the RBA monitoring incoming data before deciding on their next move.

It has been a much quieter week for the Kiwi on the data front, and so NZD/USD has taken its direction from elsewhere. Positive developments in China have been a boost, but the stronger dollar (and weaker Aussie) have been a bigger driver, with NZD/USD moving back below 0.6400, having threatened to break over 0.6600 just a week ago.

 

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