Jamie Jemmeson
July 25, 2022

Central bankers signpost towards an aggressive move whilst Truss and Sunak square off

US Dollar Remains Elevated as Inflation Pressures Remain

Whilst much of the focus in the UK was on the heatwave, and the Conservative leadership battle, significant data readings and speakers from the Bank of England kept the market on its toes. Central bank speakers continued their hawkish tone but failed to commit with conviction.

Bank of England member Saunders warned that price pressures could be harder to stop due to a declining potential growth rate. He also stated that he thought the tightening cycle still had some way to go whilst Bank of England Governor Bailey noted that a 50 basis-point rate hike is on the table at the August meeting. However, he insisted that a 50 basis-point rate hike was not locked in. Inflation post a new four-decade high of 9.4% for June from 9.1%. This was slightly above the anticipated figure of 9.3%. The core rate tipped lower to 5.8% from 5.9%. Inflation will likely push higher, with a forecast for the coming months at 11%. If we see this materialise, it will continue to pressure the Bank of England. However, whilst inflation continues to push higher, retail sales was disappointing but better than expected. Retail sales volumes fell by a smaller-than-expected 0.1% from May.

Looking to the week ahead it is quieter in terms of economic data. Whilst the majority of data released this week is second tier, the market will still keep a close eye on it for clues on the direction of the economy and the unintended impact that this could have on the Bank of England decisions regarding interest rate policy moving forward. Of particular interest will be the CBI realised sales numbers of Tuesday and the lending figures on Friday. In the meantime, the market will keep a close eye on both Liz Truss and Rushi Sunak’s bids to become Conservative party leader and by default the next Prime Minister.

ECB surprises and signpost as the market now looks to data for further clues

Last week we saw the Euro strengthen on the speculation and decisive action taken by the ECB (European Central Bank) who raised interest rates for the first time since 2011. There had been some speculation that the ECB might opt for a 50bp hike rather than the 25bp; markets were pricing in 35bp. The ECB stated that it now judged “that it is appropriate to take a larger first step…..than signalled at its previous meeting”. This was attributed to its “updated assessment of inflation risks”, in particular it seems that it thought larger first move would better help anchor inflation expectations. In addition, the ECB went on to state there is likely to be further interest rate rises but shied away from its previous ‘forward guidance’.

Looking to the week ahead, following the signposting about further hikes on the cards, the market will assess economic data to try and understand the potential limits of the policy outlook. Today the German IFO survey will provide an idea on how businesses such as wholesalers, manufacturers and builders are viewing the current and future state of the economy. However, the second half of the week sees the bulk of data releases, including unemployment numbers, from France and Germany. The market will be more focused on the inflation rate which is expected to increase to 8.7% and the GDP readings that are set for release on Friday.

FOMC takes centre stage as the US Dollar slides as rates outlook fades

The US Dollar weakened last week as the market continued to par interest rate expectations for the remainder of the year amidst concern for economic growth. To put this into perspective, 2 weeks ago the implied interest rate for December was at 3.70%, the middle of last week it had fallen to 3.50% and finally on Friday it dropped further to circa 3.3%. Whilst we have seen inflation continue to rise, this week economic data has been somewhat disappointing. Existing home sales missed expectations and was lower than the previous month whilst the Philadelphia Fed manufacturing dropped to negative 12.3 in July from negative 3.3 (reading below zero indicates deteriorating conditions in the manufacturing sector. This is the second straight month in contraction territory). Finally on Friday, the flash composite PMI output Index had tumbled far more than expected to 47.5 this month from a final reading of 52.3 in June. A reading below 50 indicates a contraction in activity – this is the contraction for nearly two years in July.

With the adjustment that we are seeing in the market towards future interest rate policy the market will pay close attention to the FOMC meeting on Wednesday. The announcement of a fourth successive interest rate increase is seen as a near certainty. However, there is some doubt over the size of the increase. Currently the market is favouring 75 basis points (circa 80% probability) with 100 basis points still on the table. However, ongoing concerns about the growth metrics being posted and forward looking means that the market is expecting circa 50 basis points in 2023. This is not one of the meetings when Fed policymakers update their forecasts and so there will be no new ‘dot plot’ of their interest rate expectations. However, both the press statement and Fed Chair Powell’s press conference will be watched for any clues on whether these expectations are shifting.