30 June 2023

GBP

BoE governor Andrew Bailey admitted this week that UK interest rates may need to stay higher for longer than had been expected, as persistent UK inflation forces the BoE’s hand. Speaking at the ECB’s annual conference in Portugal, Bailey highlighted market-implied expectations for future BoE rate hikes, saying ‘the market, I don’t think, thinks we’re nearly done at the moment. They’ve got a number of further increases priced in for us.’

Bailey is spot on, with the latest estimates predicting a new BoE terminal rate of around 6.25%, with some banks recently extending that to around 6.5%. Gulp. As we have highlighted previously, the positive impact to currencies from higher rates starts to erode considerably if recession risks increase substantially, and that is part of the reason why the pound is struggling to run up a down escalator in flippers at present. GBP/USD has now fallen by around 1.5% from the peak of 1.2840 just ahead of the last BoE meeting. However, were the dollar to resume its recent downtrend, then the pound could still be dragged higher given that the dollar side of the pair is still the most powerful draw over time.

Incoming data has hardly helped to improve sentiment, with news this week that leading supermarket Asda’s latest income tracker suggests that over 40% of UK households are not earning enough to cover their weekly expenses. The data also confirmed how much sticky inflation is impacting spending power, with those households now suffering an average shortfall of around £42.50 every week. Of course, the survey was conducted before UK rates were raised by 0.5% to 5% last week. The latest UK growth data was also released earlier this morning (Friday), with growth increasing by 0.1% during the first quarter of this year, and 0.2% on an annualised basis over the same period. In other news, the latest Nationwide House Prices confirmed an annual 3.5% decline in prices during June, with a slight (0.1%) increase over the past month. Time to batten down the hatches.

This commentary does not constitute financial advice

* Source BBC

- Joe Calnan, Corporate Dealing Manager

EUR

The ECB received a pleasant surprise on inflation from Spain of all places yesterday (Thursday), with news that Spanish inflation has fallen to 1.6% on an annual harmonised basis during June. That is an impressive decline indeed. The welcome decline makes Spain the first major European economy to see its inflation level fall to below the ECB’s 2% threshold since the beginning of the Ukraine war. This time last month, that figure was up at 2.9%, and the last time Spain’s inflation was down here was roughly two years ago. The big declines came among fuel, electricity and food prices.

The government have played a big part for Spain, issuing fuel subsidies and policies that erased the link between domestic electricity prices and wholesale gas prices, which clearly had such a staggering impact on inflation for the rest of Europe. However, Spain is lucky, given that it relied far less on Russian gas imports, and has an abundance of solar and wind power. As we often say, core inflation is another bestia altogether, and whilst still on the decline, remains at around 5.9%.

It was not such a sunny day for German inflation, which increased by 0.4% over the past month and rose considerably from 6.3 to 6.8% on an annual basis. Key Regional inflation is released later today (Friday) and is also expected to have edged slightly higher over the past month. The striking differences among inflation in the region highlight the increasing problem for the ECB. Speaking this week, Christine Lagarde remained particularly hawkish on the prospect for further interest rate rises, with another 25bps move expected next month. However, Lagarde did admit that the ECB are now moving closer to a potential pause.

As for the Euro, overall, the single currency has also witnessed a fairly flat week, with EUR/USD declining slightly to just under 1.0900. Tellingly, there has been no collapse. GBP/EUR also declined below 1.1600, confirming that the single currency had a slight edge over the pound.

USD

The strength and resilience of the US consumer continues to defy gravity and expectations at times, which can be evidenced among much of this week’s key US data. The latest growth figures confirmed that the US economy grew by 2% on an annualised basis during the first quarter of this year. That figure got a hefty upside revision from previously expected growth of about 1.3%, and upward revisions in consumer spending have clearly boosted the bottom line for GDP. Having recently risen, initial jobless claims also dropped to 239K over the past week, down from 265k in the previous week, and highlighting the ongoing tightness in the US jobs market, as we approach next week’s key June employment report.

Today’s Core PCE price index will also be key, with the latest estimates suggesting a 0.4% gain during May, and an annual figure of around 4.7%. That’s the one the Fed really care about, so markets will react to any differences against expectations. With US data still remaining remarkably robust, markets have swung heavily to favour another 25bps hike from the Fed at their next meeting. At the time of writing, the latest pricing implied around an 87% probability* for a 25bps move.

The Fed themselves have remained firmly on the fence, with Jay Powell’s speeches this week focussing on the need for the FOMC to remain data-dependent, but still highlighting their desire to continue to fight inflation. Powell also spoke more around the Fed’s decision to pause this month, and further highlighted the fact that most Fed members favour ‘one or two’ rate hikes throughout this year. Nothing new there then.

*Source: CME Markets. As at Thursday PM

The dollar has had a fairly solid week, with the dollar index (DXY) moving to as high as 103.00 at one point, clearly influenced by surging US economic data. Among the major dollar crosses, USD/JPY continues to grind higher, with the pair moving to within a whisker of 145.00, as interest rate dynamics continue to favour further upside potential. However, we are now moving into potential BoJ intervention territory, so dollar bulls might wish to tread carefully were the pair to move much higher beyond these levels, even if there was a surprising dip among key Tokyo inflation, with headline inflation dropping to 3.1% during June.

CAD

The latest Canadian CPI data gave the BoC something to smile about, slowing to its weakest pace in over two years, with key core inflation falling from 4.1 to 3.7% on an annual basis during May, comfortably slipping below analyst estimates of 3.9%. On a monthly basis, core inflation rose by 0.4%, having been expected to have increased by around 0.5%. Headline inflation also rose by less than expected over the past month, rising by 0.4%, against 0.7% previously.

The news will give the BoC some potential wriggle room to call a pause in July, after their surprising 0.25% hike earlier in the month. However, both growth and labor data will also likely need to show signs of moderation before markets can be sure that the BoC will revert back to pausing once again. With this in mind, the latest labor data is set for release at the end of next week. Last month, unemployment increased slightly from 5 to 5.2%, with the net change in employment dropping by 17.3k, having risen by around 41k in the previous month.

Having slipped to its lowest level since last September recently (1.3116), USD/CAD has risen by around 0.5% over the past week. The Loonie also looks to be somewhat shielded from the daily moves in the spot price of oil, which is usual when oil prices are steady, and more rangebound.

AUD & NZD

Much the same as in Canada, the latest Australian inflation data has thrown some serious doubt into the outcome of the RBA’s interest rate decision next week. Headline CPI increased by 5.6% on an annual basis during May, considerably lower than the 6.8% previous reading and comfortably below estimates of 6.1%. Australian inflation has now declined to a 13-month low. With inflation falling at such a fast pace, and the previous month’s finely balanced decision to raise rates by 25bps, expectations that the RBA will  to pause hikes next week, have increased considerably.

The one thing that could still sway the RBA into another hike could perhaps be core inflation, which only declined marginally from 6.5 to 6.4%. Having risen from under 0.6500 to 0.6900 in early June, the last two weeks have seen AUD/USD unwind much of that gain. At the time of writing, AUD/USD has been attempting to bounce off support at 0.6600. Of course, the decline has probably been accelerated by incoming softer inflation. With a lack of domestic influences to drive the Kiwi, NZD/USD has largely replicated the moves in AUD/USD, with the pair slipping from 0.6240 to around 0.6050 over the past two weeks.