This time last week, the BoE had just raised UK rates by 50bps, and had delivered perhaps the most pessimistic outlook from any central bank since those early days of COVID. The UK is set to enter into a multi-quarter recession, with inflation reaching the giddy heights of 13.3% this autumn, before a slow decline ensues, so the BoE tell us. We got the first evidence of the slow down today with the latest UK GDP figures showing the UK economy contracted in Q2 by 0.1%. There is an expectation that we will see small growth in Q3 however before the economy starts to contract again in Q4 as households’ energy bills are set to sky rocket.
Next week is also critical, with the latest inflation data, Retail Sales, as well as the July labour report. Headline inflation topped 9.4% last time round, which is still some way away from the BoE’s lofty projections, but within fighting distance of reaching the nasty 10% region potentially. Whilst perhaps not as critical as inflation, both Retail Sales and the Labour report will help to give a better overview of the state of the economy. A sharp slowdown in consumer confidence is expected given the big rise in the cost of living.
As for the pound, well sterling has remained close to the moves in the single currency, with GBP/EUR steady at around 1.1825. GBP/USD reached a high of 1.2280 on Wednesday, marking a strong gain against the greenback, alongside most other majors, but had slipped 100 pips by yesterday evening, as short-term profits were booked by those who had ventured on the long side.
Much the same as the pound, the single currency has had a strong week, at least when measured against the greenback. Having briefly fallen under parity in the middle of July, EUR/USD has since gradually recovered, culminating with a move over 1.0350 on Wednesday. As you will probably be able to gauge, that move was down to that weak dollar, as opposed to anything Euro area specific.
The big news on the data front was the latest German inflation report. Harmonised inflation remains lofty at 8.5% (YoY), but crucially was at the same level as the previous month, which will have given everyone a marginal sigh of relief. Today sees the release of the latest Spanish inflation report, which is expected to remain above the 10% level throughout July. June Industrial Production for the region may also reflect further softening, which is no surprise, given the challenging economic conditions within the Euro area at present.
Looking into a next week, region-wide growth figures (Wednesday) matter most. Last time round, there was a 0.7% gain (QoQ/Q2). HICP inflation follows a day after. Both will have an impact on the short-term profile for the single currency.
This week’s U.S inflation reading gave markets plenty to smile about. Finally, there were clear signs of easing, with the headline gains dropping from 9.1% to 8.5% (YoY), and a flat (MoM) print, versus 1.3% last time round. Extract the choppy food and energy prices from the mix, and the yearly Core figure remained at 5.9%, nicely below estimates of 6.1% with a 0.3% (MoM) gain, versus 0.7% previously. Much of the improvement can be attributed to an easing in energy prices through July, with big headlines coming from the news that Petrol (Gas) had fallen back below $4 a gallon in the U.S. The Fed watch that Core reading in particular, we are reliably informed.
Markets took the news in a typical market fashion, with an oversized reaction on the day. Risk assets had a ball, marking strong gains across the board, that rolled over until yesterday. In particular, the interest rate sensitive Nasdaq continued its impressive recovery. Market-implied expectations for future rate hikes were instantly reduced, with markets flipping from pricing a 75bps hike in September, to now expecting a 50bps move by the Fed. In fairness, markets had probably put too much weight behind the strong labor report a week ago, and it was probably more of a re-aligning of that hawkish rate outlook. Those members of the Fed that had the opportunity to publicly wax lyrical immediately after the release, were keen to highlight that no decision would be taken by any single data input. Indeed, amongst other key data beforehand, there is also another inflation report due before the next Fed meeting in September.
Markets will probably attempt to extract much from next week’s FOMC minutes, but the key will be how the data looks between now and September. As for the currency impact, well the dollar played to script, marking noteworthy declines against a myriad of currencies throughout Wednesday, and for a spell yesterday. The dollar index (DXY) moved as low as 104.30, but by last night’s close, the greenback had staged a worthwhile recovery. The particularly volatile USD/JPY pairing briefly traded under 132.00, but was a good 100pips higher by the European close too. As we said, it would be wrong to make too big a judgement on any single data set, a conclusion that may have eventually got into the minds of market participants. Better, but nothing to smile about quite yet, Mr inflation.
Historically speaking, commodity currencies, such as the Canadian dollar and Norwegian Krone have tended to have a close correlation to oil prices, when oil prices are either at a historical low or high point. That was especially true when oil slipped to $10pbl at the start of the COVID crisis, and when it reached over $100pbl recently.
However, there are signs that the correlation is becoming less significant, which you would expect now that the price of oil has drifted back under $100pbl of late. At the same time, the Loonie has continued its rally against the greenback, with USD/CAD moving as low as 1.2727 yesterday, even if much of that move is down to the greenback’s weakness. According to those in the know, the drop in the price of oil is more down to weaker demand, than failing supply.
Last Friday’s Canadian employment report, whilst weaker for the second month in a row, is unlikely to derail the BoC from their programme of rate hikes. However, the latest inflation reading for Canada is out next week, and if there are any sings of moderation, calls for another bumper 100bps hike come the BoC’s next meeting in September, are likely to become less pronounced.
AUD & NZD
There were strong gains to be had for both the Aussie and Kiwi through this week. AUD/USD rallied over 0.7140 – a level not traded since early June, and NZD/USD powered through 0.6400, which also last traded in early June. Clearly, both moves can once again be attributed to the weakness of the greenback. However, the AUD in particular will outpace many currencies when there is a bullish market sentiment, which has certainly been the case throughout this week.
Next week, however, is all about the RBNZ. The latest estimates are for another 50bps hike, but with a worsening economic backdrop, the move could come with a rather dovish tilt. Similar perhaps to the BoE, but without quite so much drama. Inflation has continued to edge higher, but there has been a marked slowdown in the housing market, and growth prospects are diminishing rapidly.