Weekly Brief

Germany slips into a recession

12 minute read

26 May 2023


The latest UK inflation report was somewhat mixed for April. As expected, headline CPI thankfully slipped from double digits to 8.7% on an annual basis. However, markets had been expecting a bigger decline to around 8.2%. More worrying for the BoE, was the news that core inflation increased from 6.2%, to 6.8% on an annual basis over the same period. That news is likely to keep the pressure on the BoE to continue raising UK interest rates, especially given news that Retail Sales growth remains robust (see below). Indeed, market-implied expectations now see the BoE raising rates by as much as another 75bps, before they likely reach their terminal rate. Bailey looks ruffled.

On a brighter note, the IMF now agree the UK is set to escape a recession this year, according to their latest update. Having previously expected the economy to shrink by 0.5% during 2023, the IMF have ripped-up the script and now expect a worthy 0.4% expansion over the year. That is a big change of direction. The IMF also singled-out the UK government for taking ‘decisive and responsible action’ to restore market and economic stability following the turmoil that followed Liz Truss’s ‘mini budget.’

In other news, UK public sector net borrowing reached £25.6bn in April, higher than the OBR’s estimate of £22.4bn, driven by an increase in the cost of energy support schemes and high debt interest costs, given those ongoing BoE rate hikes. The latest UK PMI data missed on both Services (down from 55.9 to 55.1) and Manufacturing (down from 47.8 to 46.9), with a big jump in prices for the Services sector, potentially adding to the BoE’s inflation problems.

This morning’s (Friday) UK Retail Sales reflected a sharp rebound of 0.5% in sales over the past month, having declined by 1.2% in March. Markets had been expecting a slightly less increase of around 0.3%. However, growth was even stronger if you exclude Fuel, with a snappy 0.8% gain, having declined by 1.4% during the previous month.

The pound has had a mixed performance over the week. GBP/USD has struggled and slipped to below 1.2330 for the first time since the beginning of April, driven largely by those strong dollar gains (see USD). However, the broader pound has fared much better, with GBP/EUR moving to 1.1550, recording the highest level for the pair this year, albeit for a short spell.

“GBP is at a tipping point, and which way it falls will be the key to the direction of the Pound moving forward. Inflation has dropped below double figures and ended up at a mere 8.7% - a full 0.5% higher than expected. Here's the rub: high inflation should support a country's currency through higher interest rates. However, when an economy is built upon debt, higher interest rates can also break it. And that's the situation we find ourselves in – GBP has to date remained supported by higher rates; however, with The UK narrowly missing a negative growth print for Q1, how much longer can GBP hold onto those gains? Clients recognise this fact and have increased their levels of protection while the Pound remains towards the top of its 12-month range.”

This commentary does not constitute financial advice

- Daniel Jones, FX Dealer


It has been another week to forget for the single currency. A combination of a stronger dollar, coupled with weaker European economic data, has culminated in manifesting another considerable leg lower for EUR/USD. Having been as high as 1.1090 at the beginning of May, the pair has now declined to just above 1.0700. That is a fairly big hit in less than a month and takes us back to levels last witnessed in March.

As we mentioned above, the latest incoming European data has been a big factor impacting the sudden decline in the single currency. Germany continues to remain front and centre of the negative news, and following on from weak manufacturing data, the latest GDP figures confirmed yesterday (Thursday) that Europe’s biggest economy had now fallen into a recession*. Growth declined by 0.3% over the past quarter. Markets had been expecting a flat reading for the period. The latest German IFO survey also disappointed, highlighting the first decline in seven months for both the Business Climate and Current Assessment components.

To complete the bleak data-set, PMI data also largely disappointed in Europe, with Germany’s Manufacturing PMI slipping from 44.5 to 42.9. Markets had been expecting a slight improvement, albeit a long way away from the key 50 threshold. However, there was better news among services, rising from 56, to 57.8 and helping to push the composite up to 54.3. The picture was replicated at regional level, with a weak manufacturing backdrop eclipsed by strong growth in the services sector.

Next week’s incoming European data may give the single currency an opportunity to correct some of the recent declines, with key inflation data set to take centre stage. Of course, the higher the inflation print, the more hawkish one might expect the ECB to behave, and thus fuel increasing market expectations for future hikes.

*Two consecutive quarters of negative growth are normally considered as a technical recession


Events in the US continue to drive broader market sentiment, with the two key questions of; a) Will the Fed hike or pause at next month’s meeting? and b) Will the authorities be able to raise the debt ceiling? completely dominating risk sentiment.

On the former, markets have been left somewhat frustrated by the lack of clarity on the outcome from the Fed. The Fed have themselves been clear to stress that they will assess all incoming data before deciding on whether to hike or pause at the meeting. Indeed, Jay Powell said last week that the next move remains unclear, and that message came through loud and clear in the minutes of this month’s meeting. As we often say, it is an uncertain backdrop that unsettles markets most, and volatility is likely to remain heightened leading into next month’s meeting. At the moment there remains a fairly even split on market-implied expectations for the outcome.  

On the debt ceiling, the lack of progress continued to frustrate markets throughout the week. Towards the end of the week, Fitch (a rating agency), placed the US on negative watch for a possible downgrade next Wednesday, were the sides unable to reach agreement in time for Yellen’s ‘X-date’. Yellen had earlier reiterated that the US government might not have the resources to meet all of its obligations ‘possibly as early as June 1.’ She also stated that she was planning to update congress with a more precise estimate. The latest ‘news’ is that the two sides are moving closer to finalising the agreement over the coming days, with both sides implying that the talks were in a better place.

Whilst it might sound counter-intuitive, the negative backdrop has helped to support the dollar, which historically tends to benefit from periods of market uncertainty. The dollar index (DXY) moved close to 104.00, the highest level for the greenback since March. Aside from EUR/USD (see EUR), much of the move can be attributed to the rally in USD/JPY, which has risen all of the way to just over 140.00. That move perhaps makes sense, given the expanding interest rate differentials between the US and Japan.

On the data front, next week will be dominated by the May employment report, with markets currently expecting a slight reduction (to about 180K) in headline Nonfarm payrolls, given the strong 253K gains last time round. On that note, we also need to keep an eye on revisions, after the previous monthly figures were revised considerably lower.


There was a 1.4% decline among Canadian monthly Retail Sales during March, with much of the decline being attributed to slower sales among cars, parts dealers and gas stations, the latest data confirmed last Friday. In their initial ‘flash’ estimate, sales are also expected to have risen by 0.2% during April. USD/CAD had a 1.3400 – 1.3570 range throughout last week.

Having been on a four-week decline, Oil prices have recovered somewhat over the past week and a half. However, that has done little to support the Loonie, with USD/CAD also rallying to as high as 1.3640, a level that had last been breached at the beginning of the month.

Aside from the (US) dollar side of the pair, those weak Canadian Retail Sales may have impacted the BoC’s thinking, and their decision to pause is currently looking a little more justified. However, next week’s growth figures may also play a part, and more robust growth could send the barometer back in favour of the hiking camp.


As expected, the RBNZ hiked New Zealand interest rates by another 25bps to 5.25% this week. However, in a highly surprising move, the RBNZ then suggested that no further policy tightening would be required to tame inflation. That news weighed heavily on the Kiwi, with NZD/USD slipping by around 1.6%, to levels last seen at the beginning of May. The RBNZ may have had one eye on the latest New Zealand Retail Sales, which slipped by a whopping 1.4% during Q1, and came in much worse than the 0.4% decline expected. The pair has since declined to around 0.6050.

The latest Australian PMI data beat estimates, with Manufacturing increasing from 47.3, to 48 and Services slipping from 53.7 to 51.8, against an expected decline to 48.9. As we have said before, the strength of the services sectors around the world is currently a big driver to ongoing inflation rises, and the same looks the case in Australia. The latest Retail Sales were released earlier this morning, and the data flatlined, slightly missing the 0.2% gain expected.

As for AUD/USD, well it has struggled much the same as the Kiwi, slipping back to test 0.6500 support for the first time since November.



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