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FX markets take stock of recent comments whilst Russia defaults

FX markets were less volatile last week as market participants took stock of recent comments and policy changes. Sterling held its ground despite some concerning consumer data and further political changes. UK inflation hit a 40-year high with an increase to 9.1% from 9.0%.

However, the underlying rate declined slightly, more than expected, to 5.9% from 6.2%. This coincided with Bank of England MPC member Mann stating that there are signs that inflation in the UK is becoming more embedded and persistent.

UK economic activity and the consumer

In the second half of the week, data focused more on economic activity and the consumer. The UK PMI Business Confidence data recorded a decline in the manufacturing index to a 16-month low whilst the GfK Consumer Confidence Index dipped to a record low.

Following this, retail sales in the UK showed a fall of 0.5%, providing further evidence of the impact on consumers of the rising cost of living. The combined effect of rising inflation and slowing growth puts the Bank of England in a difficult position.

On the political front, PM Johnson’s position became more challenging. The Conservatives suffered a double defeat in separate by-elections, prompting the resignation of Oliver Dowden Conservative Party Co-Chairman.

The US’s need to be nimble

Fed Chair Powell testified to Congress, stating that the central bank is strongly committed to bringing inflation down. He anticipates ongoing rate increases will be appropriate. He added that inflation clearly surprised to the upside. Further surprises could be in store with the Fed needing to be nimble.

Powell reiterated that the pace of future rate increases will depend on incoming data and the evolving economic outlook. When asked whether a 100 basis-point hike was possible, he stated that nothing is off the table, but it was unlikely. In the meantime, concerns for sustained growth may start to rise as the US PMI manufacturing index dipped to a 23-month low.

Recession risks in the EU

The Euro remains muted against a stronger US Dollar following comments from ECB President Christine Lagarde that the central bank must be attentive to recession risks as growth forecasts continue to be cut and increasing concerns about a cut in gas supplies. The Euro-Zone manufacturing index dipped to a 22-month low. This was below consensus forecasts while the services-sector index declined to a 5-month low. Overall business expectations also declined to the lowest level since October 2020 as new-orders growth stagnated.

Over the weekend, Russia defaulted on its foreign debt for the first time since 1918, largely a result of sanctions that had shut down payment routes for the nation. G7 leaders at their summit in Bavaria are expected to commit to providing support for Ukraine for “as long as it takes” according to a draft statement.

ECB forum takes centre stage as world central bankers discuss policy.

In the last week, we saw the market taper its expectations of rate hikes. With that said, by the middle of next week, the Fed Reserve are expected to raise rates to 3.5%. The UK anticipates rates to rise by 175 basis points for the same period.

However, ECB President Lagarde that the central bank must be attentive to recession risks as growth forecasts continue to be cut. Lagarde is due to deliver welcoming remarks at the ECB Forum on Central Banking on Tuesday before taking part in a panel discussion on titled “Policy panel” alongside BoE Gov Bailey and FOMC Chair Powell. Outside of the ECB Forum, the market will also look to the unemployment data on Thursday and the inflation data on Friday.

Will Powell curb market expectations as data expected to soften?
Powell will follow up in testimony in Washington by taking part in a panel discussion on titled “Policy panel” at the ECB Forum on Wednesday. The market may be interested to understand more as economic data starts to tread a similar path to data in Europe and the UK in softening.

Data this week includes durable goods today and consumer-confidence tomorrow which are both expected to soften. Inflation data in the form of the PCE (the Fed’s preferred measure) is released on Thursday and the ISM manufacturing is due on Friday. If these soften as well, the market could taper rate expectations.

Could Bailey highlight concerns of recession?

It is a quieter week in terms of economic data with the mortgage and lending figures due on Friday. BoE Gov Bailey’s involvement in a panel discussion on titled “Policy panel” at the ECB Forum on Wednesday will be scrutinised. The BoE raised interest rates by 25 basis points and signposted more aggressive action in future.

However, economic data is looking softer and concerns about a recession are rising. If we see these become more prevalent could the BoE change its path? The UK expects to see rates rise by 175 basis points to 3% over the next 12 months. If we end up in a recession, will this still be the case?

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