The media attention in the UK was focused on the ongoing saga and uncertainty surrounding “partygate”. The Sue Gray report on the Downing Street parties is still under wraps as legal issues are being debated due to an official police investigation starting. In terms of economic data, it was a mixed week in terms of results. The UK PMI manufacturing and service sector indexes were released. Both figures declined to an 11-month low in December. The manufacturing output index, however, strengthened to a 5-month high while there was a slight easing of cost pressures. The CBI retail sales index strengthened sharply to 28 in the year to January from 8 the previous month and well above market expectations of 13. However, this was largely ignored due to the inflated nature of the figure as last January harsher lockdown restrictions were in place. Inflationary pressure remains a cloud over February’s outlook and markets remained wary over the squeeze on incomes during the second quarter.
The week ahead will have a big focus on the BoE meeting where the market is expecting interest rates to be raised; the first back-to-back set of hikes since 2004. With a rate hike being fully priced in, the key focus will be on the rhetoric that follows. Last week we saw the Federal Open Market Committee (FOMC) rhetoric change opinions on the direction on the outlook for interest rates; could the BoE messaging do the same? Goldman Sachs Group Inc. expects the BoE to raise interest rates three times this year; potentially on a back-to-back basis which could mean interest rates at 1% by the end of May.
Will Labour Data Reinforce FOMC Rhetoric?
Last week we saw the US Dollar strengthen following the FOMC meeting. The Federal Reserve (Fed) provided the market with the anticipated hawkishness at its January meeting. The FOMC’s statement included the information that had been expected as policymakers voted to keep rates on hold, however, the positive comments in the press conference saw the Dollar index hit a 3-week high. Fed Chair Powell noted in his press conference that the central bank is ready to raise interest rates and didn’t rule out hiking at every meeting to curb the highest inflation pace in a generation and ending its tapering programme by March. Powell further noted that there was ‘quite a lot of room to raise rates without impacting the labour market’ and that the Fed may start to reduce its asset holding later in 2022. This has resulted in the market pricing in a 90% chance of five quarter-point hikes in 2022, however, this may be subject to change as we see more data throughout the year. His rhetoric was further reinforced as the GDP data hit the wires, the economy expanded at an annualised rate of 6.9% in the fourth quarter, from 2.3% previously and above expectations of 5.5%.
Looking to the week ahead the market will focus on the data release from the US to decipher the spare capacity in the economy and whether 5 hikes for 2022 is realistic. The risk of raising interest rates this quickly is that it will slow economic growth. The ISM Manufacturing (Tuesday) and Services (Thursday) data is set for release and will provide a good indication of economic activity within these sectors. The labour data will be of particular interest following Fed Chair Powell’s comments last week. The ADP employment report (Wednesday) and the all-important Non-Farm Payrolls (Friday) are also set for release. The headline Non-Farms Payroll are expected to publish job creation of 179k; if we were to see softer numbers then interest rate expectations could dampen.
ECB Meeting Could Alter Path of Interest Rates
It was a mixed week for Germany as survey data was positive but data showing economic activity was negative. The German IFO confidence index exceeded the forecast yesterday, strengthening to 95.7 for January from 94.8 in December and a forecast of 94.6. The increase in the expectations component of the index represents the first since June last year, providing a glimmer of hope for the German economy during the potential backdrop of a German technical recession. However, the German Prelim GDP showed a -0.7% contraction for the fourth quarter of 2021. This was a greater contraction than expected, with the consensus being -0.3%. Conversely, French Flash GDP showed a 0.7% expansion in the fourth quarter of 2021 representing the fastest GDP growth for the French economy last year in five decades. Overall GDP growth achieved 7% in 2021, the highest since 1969, following an 8% contraction in 2020 due to COVID-19 lockdown restrictions.
The market will focus on the European Central Bank (ECB) meeting this week. Record Eurozone inflation rates mean price pressures will be at the top of the agenda for ECB policymakers at their meeting on Thursday. No immediate policy action is expected since the ECB in December laid out plans to wind up its €1.85 trillion. ECB Chief Economist Philip Lane said last week the ECB would tighten policy if inflation was seen holding above its 2% target. Comments from senior officials in the region have been mixed on the path of inflation, so guidance from the ECB could result in a roadmap for tightening policy being amended.
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