Hiking into the wind
View from the Trading Desk:
Policy action by the ECB and Federal Reserve has made the equation pretty simple for the Bank of England this week—rates must rise by at least 50 basis points, the most significant increase since 1995. Faced with the worst bout of inflation in the last 40 years, BoE Governor Andrew Bailey and his Monetary Policy Committee colleagues cannot afford to fall further behind the curve. Bailey has warned that prices could leap 11% this year, a world away from the bank’s 2% target. Seriously, even McDonald’s has resorted to raising the price of a cheeseburger for the first time in 14 years by a whopping 20%! To complicate things, Bailey and other central bankers are having to front-load tightening amid a worsening global growth outlook. On this, the IMF has forecasted the UK to post the slowest growth in the G7 for 2023.
Logic dictates that with the BoE set to continue raising rates and businesses looking to protect their profit margins, most sectors of the economy will continue to see prices increase aggressively. This poses a major headache for Britain’s incoming Prime Minister, with both Sunak and Truss promising fiscal action to support UK households. Even the fiscally frugal former Chancellor has come out over the weekend promising the biggest income tax cut in 30 years, from 20% to 16% by the end of the next Parliament. Meanwhile, it’s been estimated that the stimulus promised by Truss’s campaign will force the BoE to raise rates well past 3%. After all, with the current cost-of-living crisis, any extra cash in pockets will be spent rather than saved.
Bottom line: This week’s BoE action is likely to underpin the Pound’s value after its 10% fall against the Dollar this year, and with markets seeing rates creeping more towards terminal levels, we might see a little more positivity creep into the narrative. Still, don’t be fooled; the days of GBP/USD at $1.40+ are unlikely to be in scope any time soon. With the outlook still so uncertain, we’d consider taking advantage of any bout of Sterling strength—it could be short-lived.
The week ahead
Focus for the Pound will be centred around the Bank of England this week, with expectations of a 50 basis-point hike gaining some significant traction. The Pound Index has climbed 1.50% since the start of last week on the back of higher rate expectations. Should the BoE act cautiously and opt for a 25 basis-point move, the Pound could face some renewed weakness. The UK Manufacturing PMI has fallen to a 25-month low as output pulls back, and the threat of a recession looms. PM candidate Liz Truss has emphasised there will be no vote on Scottish independence should she become Prime Minister, despite Nicola Sturgeon organising a provisional vote for October next year.
- The Nationwide HPI m/m for July will be released on Tuesday; home prices are expected to rise 0.2%.
- The UK Construction PMI is due on Thursday; analysts are expecting a 52.0 print for July versus 52.6 in June.
- Thursday will see the Bank of England deliver its latest interest rate decision; markets expect a 50 basis point move, pushing the headline rate to 1.75%, the highest since 2009.
- BoE Monetary Policy Committee member Huw Pill will speak this Friday with insight into the upcoming rate decision expected.
The Euro remains one of the worst-performing G10 currencies so far this year as the common currency continues to trade close to parity against the US Dollar. Credit Suisse places a 50% probability on a recession in the Eurozone this year as disruption of energy supplies out of Russia continues to drive the current market narrative. This has helped to push forecasts lower as JPMorgan sees a $0.95 handle on EUR/USD by the end of the year. An Italian election scheduled for September is another point of concern with the ECB’s ability to manage borrowing costs in the region potentially at risk depending on the outcome of the voting.
- Spanish Services PMI will be published on Wednesday; analysts are expecting a 52.0 print for July.
- Eurozone PPI m/m for June is projected to read 1.0% versus a 0.7% gain in May.
- Eurozone Retail Sales m/m are forecast to print at 0.0% in June compared with 0.2% in May.
- To end the week, German Industrial Production m/m is expected to decline by 0.4% in June.
US Dollar strength has waned in recent weeks despite the Federal Reserve delivering yet another 75 basis-point rate hike at its last meeting. Weak economic data out of the US has been a concern for investors as the talk of peak Fed hawkishness begins to creep into markets. It seems unlikely that the Fed will slow its rate hiking cycle significantly. Still, moving to a more moderate 50 basis-point hike at their next meeting could be possible as the US tips into a technical recession. President Joe Biden will discover if his trip to Saudi Arabia was fruitful or not this Wednesday as OPEC+ producers deliberate increasing oil supplies.
- The US ISM Manufacturing PMI is due for release at 3PM today; expectations are for a 52.0 print. The ISM Services PMI is also scheduled this week, with forecasts pointing to a 53.7 reading.
- The latest JOLTS Job Openings will be published on Tuesday, with 11 million openings projected.
- US Non-Farm Payrolls for July is expected to hit the tape on Friday with another 250K more people in employment as the US labour market continues to show strength.
- Federal Open Market Committee members James Bullard and Loretta Mester are scheduled to speak this week.
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