Weekly Brief

Flawed guidance?

GBP

The latest UK inflation report must have made for some fairly sombre reading down at the Bank of England. With headline inflation rising to 9.4% (YoY) from 9.1%, and much of the rise being attributed to higher energy prices, the BoE’s MPC will face some tough choices ahead. BoE governor, Andrew Bailey, suggested that the BoE would be prepared to increase the level of rate hikes from 25bps to 50bps, during a speech earlier in the week. Given the move by the ECB (see EUR) it would be no surprise if the BoE did as much, at their next meeting in August. The BoE may actually have a window to justify a bigger hike, given that recent data in the shape of the monthly GDP and employment report, have both beaten estimates. We just need to get to August in one piece.

In a week when the race to become the next Tory party leader was whittled down to Rishi Sunak and Liz Truss, with both suggesting that they would cut taxes if successful, the Office for National Statistics (ONS) released the timely publication of the latest UK debt interest payment report. The UK government are now paying an eye-watering £19.4bn a month in debt interest payments, which is up a whopping £10.3bn from this time last year. To make matters worse, around a quarter of that figure is linked to inflation. Ouch. Either Sunak and Truss have the magic powers beyond that of the great Houdini, the world’s largest sofa to find the cash from, or their desire to please the nation by cutting taxes will be restricted by the servicing of existing debt further down the road. Time will tell.

As for the pound, well sterling has had a steady week. GBP/USD moved back beyond 1.2000 for a spell, with most of that move being driven by positive market sentiment, which has been a strain on the greenback. On the data front, today’s Retail Sales, down 5.8% (YoY/Jun) versus -5.3% exp, may have given the BoE a reminder that all is not well for the UK consumer.

EUR

After 11 years, the ECB finally raised Euro area rates yesterday afternoon. The surprising news was the size of the hike, and at 50bps (on the main refinancing rate), was twice the amount that Christine Lagarde had promised would be forthcoming from the ECB this month. Given that the trend for central banks recently has been to promise one thing to markets and then deliver something completely different, one wonders whether the policy of central banks giving markets forward guidance is rapidly becoming pointless and redundant.

The ECB confirmed as much during their post-meeting press conference, with Christine Lagarde suggesting that each meeting will be live and data dependent, and that the need for the ECB to raise rates by a larger amount was put into place shortly before the meeting, as indicators pointed to a further deterioration of the inflation outlook. We touched on this in our daily commentary earlier in the week.

Lagarde also gave more colour on the new ECB bond purchase scheme, Transmission Protection Instrument (TPI), which should help to cap borrowing costs for the more indebted nations within the EZ, as the ECB embark on further rate hikes down the road. Indeed, markets have now priced in around 60bps worth of hikes by the ECB for their next meeting in September. Within a few hours, the Danish central bank also raised rates in Denmark by the same margin, from -0.6% to -0.1%.

After initially rallying as high as 1.0280, EUR/USD was unable to sustain the upside momentum, and slipped back under 1.0200 by this (Friday) morning. GBP/EUR mirrored EUR/USD, slipping as low as 1.1640, before bouncing back over 1.1700 after the ECB press conference. Perhaps part of the reason for the abandoned rally in the single currency may have been markets having one eye on the developing political story in Italy. After an explosive week, Mario Draghi resigned as prime minister and dissolved parliament, initially placing further pressure on Italy’s borrowing costs.

USD

With markets in a positive vibe over the past week, the greenback has struggled to maintain its recent gains across the board. The dollar index (DXY) has therefore subsequently declined in a steady fashion from 109.00 to around 106.00. Even USD/JPY has slipped from the recent high of 139.40 to around 137.80, despite the BoJ keeping policy unchanged at this week’s meeting.

Overall data is the U.S has been a bit of a mixed bag, with many positives such as stronger Retail Sales, evidence of more anchored consumer inflation expectations, and the labor market remaining robust. However, on the downside, the housing market has been particularly impacted by the Fed’s rate hikes and mortgage applications have now dwindled to levels not seen for over 22 years.

With the next FOMC meeting just next week, there will be much speculation as to whether the FOMC maintain the 75bps hike pace, or decide to go for a bolder 100bps move instead. Many will argue that the Fed will keep to 75bps, given that recent long-term consumer inflation expectations have steadied, and it has been widely reported that it was this metric that forced the fed to increase the pace of hikes last month. However, calling central bank moves has suddenly become a more challenging task, and the outcome is far from assured.

Whatever the Fed do, the next meeting after July is not until September, and will give both the Fed and markets time to assess the ongoing state of the U.S and broader global economies. Indeed, just a day after the Fed, we will get the latest U.S (Q2) growth report. As for the dollar, well the short-term direction looks to continue to be guided by broader risk appetite, and so far, that is holding-up well.

CAD

Just a week after the BoC’s Fed-beating 100bps rate hike, the latest Canadian inflation report was released. Interestingly, whilst core inflation moved up from 6.1% to 6.1% (YoY/Jun), that number was much lower than the 6.7% analysts had expected. The headline rate jumped from 7.7% to 8.1% during June, with much of that increase being attributed to higher fuel costs and ‘almost everywhere else,’ said statistics Canada. You have to admire their honesty.

The tough bit is interpreting what the BoC will make of it all. On the one hand, the latest inflation number is not as bad as it could have been, however, inflation is still accelerating, and Canada has its highest inflation rate in 40 years or so. The next BoC meeting is in September, and much like in the U.S, by then we will have had longer to assess the health of the Canadian economy.

Despite oil prices regularly moving back below $100pbl recently, the Loonie has fared far better this week, than it did after the BoC meeting last week. USD/CAD has moved from a high of over 1.3230 last Thursday, to around 1.2850. Clearly, that greenback weakness has been the major driver. Elsewhere, GBP/CAD has been steady around 1.5400.

AUD & NZD

The RBA will be the subject of a ‘broad based’ review of its inflation targeting arrangements, mandates, performance and governance, according to Australian treasurer, Jim Chalmers. The review follows criticism of the RBA’s handling of rising inflation, with concerns over their apparent slowness to raise Australian interest rates, despite the economy accelerating rapidly after COVID lockdowns.

Despite this, Australia’s prime minister, Anthony Albanese, has also warned the RBA against ‘overreach’ in its efforts to tame inflation. These comments came after RBA governor Lowe, highlighted that Australian interest rates could rise to at least 2.5%, over the coming months. AUD/USD has continued its recovery from under 0.6700 throughout this week, marking a high of just over 0.6900. Next week, the latest Australian retail Sales (Jun) are the pick of the bunch.

Much the same as the Aussie, the Kiwi has recovered well of late. The broad greenback weakness has been a big driver, especially given that economic data in New Zealand has not exactly impressed, with a worsening Trade Balance, as well as economic worries driven by China’s latest COVID-driven lockdowns. NZD/USD moved as high as 0.6270, and with a fairly light data agenda, is likely to take its lead from the greenback and risk sentiment.

 

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