View from the Trading Desk:

The Bank of England's Monetary Policy Committee has a difficult decision on its hands. The market is pricing in a 0.5% interest rate hike for the MPC's August meeting—bringing the policy rate to 1.75%—and an additional 1.0% in hikes by the end of the year. That's punchy! This Wednesday, when UK GDP growth data is released for May 2022, it's likely to show additional contraction after April's -0.3% print. One doesn't require a Master's degree in Economics to work out where this is going. The UK is likely to have experienced a quarter of negative growth in Q2; only one more is required for the official label of a recession.

While the labour market is very strong at the moment, the growing number of job openings is likely to drive a wage-price dynamic higher because of structural labour supply limitations (i.e., Brexit).
 
 
Source: Office of National Statistics (June 14 2022)

Again, looking at the inflation forecast data says more than words can. Despite 1.15% of interest rate hikes over the past year, inflation is expected to continue to trend toward new highs, which means higher rates have done little to slow price growth.


Source: Bloomberg

Bottom line: No wonder the MPC has been taking a 'we're hiking but ready to hike faster' stance in recent speeches. Without much imagination, one can see that the BoE will likely need to drive the UK into inflation to curb these expectations, economic growth be damned. If the next Prime Minister also sees tax cuts as a priority, investment in infrastructure and education is likely to be cut as a consequence, driving future growth lower. What's more, the Federal Reserve doesn't face a trade-off quite this stark between inflation and growth, but it's driving rates higher with gusto. If the BoE lags behind even a bit, inflation expectations will likely climb further and drive Sterling lower, intensifying the imported inflation problem. With Boris Johnson a lame duck, it's unlikely the government will be able to meaningfully address the labour shortage issue before the end of the year. So there it is. We're stuck where we are from a structural perspective; forced to play out the game with the current hand, with the MPC likely to drive the economy toward recession and investment likely to sink. It's really difficult to view Sterling as oversold in this context.
 

The week ahead

GBP 

The Pound began last week on the back foot, falling an initial 1.1%, before erasing all losses on Thursday as British Prime Minister Boris Johnson finally resigned following a series of political scandals. Broad-based US Dollar strength has taken the GBP/USD pair down below the 1.20 interbank level, meaning that the Pound has now lost almost 14% of its value against the Greenback from one year ago. Still, Sterling looks set to gain ground against other major currencies, mainly the Euro and those which have benefited from the rally in commodities in recent months. Major events this week will centre around the race to lead the Conservative Party, with eleven names currently in the hat.

• Bank of England Governor Andrew Bailey will testify on Monday at 3:15PM on the BoE’s Financial Stability Report in front of the Treasury Select Committee.
• Tuesday sees the British Retail Consortium release its Retail Sales Monitor for June, with the expected figure -1.2%, up from -1.5% previously.
• Andrew Bailey will also speak at 6:00PM on Tuesday about the economic landscape at an event hosted by the Official Monetary and Financial Institutions Forum.
• UK GDP for May will be released on Wednesday morning. The expectation is for no growth after a -0.3% decline in output for April.

 

EUR

The common currency finds itself creeping closer and closer towards parity as US Dollar strength rips unabated through markets. The EUR/USD pair fell as low as 1.0072 on Friday before recovering back to around 1.02 to end the week. Data-wise, it’s due to be a relatively quiet week in the Eurozone, except for the EU’s quarterly economic forecasts on Tuesday. Euro weakness might be exacerbated by concerns over gas supplies from Russia and economic slowdown in the region. Markets will also be eyeing next week’s European Central Bank meeting, where officials are set to raise interest rates for the first time since 2011.

• Today at 5:30PM, the German Bundesbank (Buba) President Joachim Nagel will speak about the Digital Euro at an event hosted by the Institute for Monetary and Financial Stability.
• On Tuesday, the German ZEW economic sentiment survey will be released. The expected figure is -40, down from -28, highlighting the extreme pessimism among German investors.
• The EU’s latest quarterly economic forecasts will also be released on Tuesday. These forecasts cover EU member states over the next two years.
• European m/m Industrial Production for May is due on Wednesday morning, with a 0.2% increase projected, down from 0.4% previously.

 

USD

It appears nothing can put an end to the US Dollar’s latest rally, with the world’s reserve currency strengthening to levels not seen since the very beginning of the Covid-19 pandemic. On a trade-weighted basis, the Greenback has risen nearly 16% since June 2021 as investors seek safe-haven assets while global risks mount. After Friday’s better-than-expected Non-Farm Payrolls read, markets will be watching Wednesday’s inflation print closely to realign bets on Federal Reserve policy tightening at the July 27^th meeting.

• US Consumer Price Index and Core CPI for the month of June are due out on Wednesday afternoon. The core measure is forecasted to increase by 0.6% after the same increase last month. Meanwhile, the overall figure is predicted to jump another 1.1% after 1.0% previously.
• On Thursday, Federal Open Market Committee member Christopher Waller is due to speak about the economic outlook at the Annual Rocky Mountain Economic Summit.
• Friday will see the release of Retail and Core Retail Sales m/m for June. Core sales are predicted to rise 0.7% from 0.5% previously, while the overall measure is expected to increase 0.9% after a 0.3% fall last time.
• The preliminary University of Michigan Consumer Sentiment will be released on Friday afternoon. The survey is expected to show that confidence levels have dropped to 49 for the month of July, following a reading of 50 previously.

 

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