Jamie Jemmeson
July 6, 2022

Sterling remains fragile amidst fresh political drama

Energy price forecast reinforce recession forecasts

Sterling slumped against the US dollar, hitting a new two-year low on Tuesday as markets focused on safe-haven currencies after another surge in European gas prices reignited recession fears. Economists warned of the risk of Europe backsliding into a recession. Concerns grew after a large jump in natural gas prices in both Europe and Britain – set to push inflation even higher.

In terms of economic data, the UK PMI services-sector index recorded a final reading of 54.3 for June from the flash reading of 53.4, with reports of strong spending in the travel and leisure sectors providing underlying support.

There was fresh political drama after the European close with the resignations of Chancellor Sunak and Health Secretary Javid. There was intense speculation that Prime Minister Johnson would resign as uncertainty spiked higher. With Zahawi’s appointment as the new Chancellor, there will be speculation over a shift in economic policies amidst Sunak’s parting comments in his letter. Sunak stated, “In preparation for our proposed joint speech on the economy next week, it has become clear to me that our approaches are fundamentally too different.”

Looking at the remainder of the week, the market will focus on the UK political challenges and how stable PM Johnson’s government remains. Given the economic backdrop and Sterling’s position, the market will be keen to see central bankers’ views. Wednesday sees BoE Chief Economist Pill and BoE Deputy Gov Jon Cunliffe speaking at the London Global Banking and Finance Conference. BoE member Mann is due to speak on Thursday.

Dollar hits 20-year highs on global recession concerns

The US dollar continued to trade at elevated levels against several significant pairs early this week. The US dollar Index reached its highest level in nearly two decades, above 105.50. Financial markets remain fragile amid concerns that rapidly rising interest rates and tightening financial conditions would challenge global economic growth.

Apart from this, the ongoing Russia-Ukraine war and the COVID-19 outbreak in China fuelled global recession fears. This, in turn, tempered investors’ appetite for perceived riskier assets, evident from a fresh move lower in global equity markets. The Federal Reserve’s continued commentary about rate hikes to curb soaring inflation gave support to the US dollar. Besides this, the widespread risk-off environment boosted the safe-haven dollar.

Looking to the remainder of this week, investors’ attention will surround the Fed Minutes report from the previous meeting, where they surprised markets, raising rates by 75 basis points. Powell indicated at the Fed’s most recent meeting that evidence of rising longer-term inflation expectations justified the larger than expected hike in June.

Also scheduled for release are US factory orders, followed by ISM Services data released on Wednesday. The standout economic release comes on Friday, where investors will review the latest labour market report. The US economy expects to add 295k jobs in June, slowing from May’s print of 390k. Unemployment is likely to hold steady at 3.6%. Average hourly earnings are forecast to maintain monthly growth of 0.3%, which would point to real wage growth remaining negative in June.

Energy price pressures weigh on the euro

While there was no particular catalyst that sparked the sell-off, a combination of factors continues to weigh heavily on the single currency, which dropped to a fresh 20-year low against the US dollar on Tuesday this week. ECB’s Nagel comments did little to support the euro early in the early stages of this week, warning against using monetary policy aggressively should only be used in exceptional circumstances.

Meanwhile, Russian gas deliveries to Europe fell 40% in June, which kept Europe’s power prices pressured to the upside. In a further sign of increasing gas prices, the Nord Stream is due to close entirely for its annual maintenance shutdown on July 11-21st. However, the concern across financial markets is that the pipeline may not come back online when scheduled.

Looking ahead to the remainder of this week, with little in the way of economic data from the Eurozone, the currency will likely take its cue from upcoming US data this week, which includes the Feds Minutes report and the US jobs report on Friday. In terms of Eurozone releases, investors will focus on Eurozone Retail sales on Wednesday and German Industrial production set for release on Thursday.

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