United Kingdom – signs of economic problems increase

The first week of 2023 ended with little sign of a let-up in the negative economic news. Footfall as recorded by Springboard and the British Retail Consortium was still significantly below 2019 levels, the last time retail was unaffected by COVID. Moreover, the postal strike was seen as a positive factor to encourage high street activity in the run-up to Christmas. 

Over the weekend, reports from Make UK, a lobby group representing the manufacturing sector, warned of job losses because of the energy price increases pressuring profit margins, whilst the official register of insolvencies reported a 65% rise in the first week of January compared to the same period a year earlier. 

The inflation threat remains as far as the UK is concerned, and markets still expect something between a 25 or 50 basis point hike in February from the BoE (Bank of England), albeit sentiment continues to lean towards 50 basis points. Further interest rate hikes from this point on won’t help the UK’s economic outlook, and the BoE will be closely watching headline inflation to see if it dips in the same way as inflation rates in the US and Euroland. With gas prices collapsing and consumers tightening their spending behaviours, the risks are for an undershoot of inflation versus BoE projections.

As for the GBP, it finished last week on a positive note against the USD, but little changed against the EUR or JPY. With little data or surveys to help, the GBP will struggle to outperform, in my view.

Europe – can the European Central Bank ignore weakening inflation and economic data?

The ECB (European Central Bank) will have observed the slump in consumer price inflation seen last week, with the December headline rate dropping to 9.2% year-on-year from 10.1% in November, although the core CPI (Consumer Price Index) rate climbed from 5% to 5.2%. There was weakness from the German factory orders data for November as well, pointing to a pullback in production in the months to come, which will act as an additional drag on the German economy, and therefore also on Euroland activity.

This week has already seen the Sentix investor confidence reading improve marginally more than expected in the January reading, and German industrial production held up better than expected. Towards the end of the week, there is Euroland industrial production due. Some modest growth is expected from this, but it is unlikely to alter sentiment on interest rates or the euro.

Speeches from de Cos, Knot, Holzmann and Villeroy could be of interest to the financial markets, along with the January economic bulletin from the ECB. How much further does the central bank believe it can tighten without creating even worse economic conditions? So far the moves in currency markets have had little, or nothing, to do with Euroland’s economic outlook, albeit it has been helped by the warmer winter so far, and the drop in gas demand that has accompanied this.

United States – Fed warns markets that the US rate peak may need to be higher, just as data suggest rates are beginning to bite

The key highlights from the first week of 2023 in the US included a warning from the Federal Reserve. In its minutes, it stated that market forecasts of the interest rate peak might not be high enough, there are some strengths in the US labour market, but also weakness in average earnings and a much lower than expected services ISM (Institute for Supply Management) for December.

It was the last two releases of last week that prompted the US dollar to give back virtually all of its gains against the likes of the GBP, EUR and JPY. Furthermore, the poor economic news reduced US interest rate expectations for the February FOMC (Federal Open Market Committee) meeting. Now the markets think the Fed is more likely to hike by 25 basis points versus 50 basis points, but the messaging from the Fed appears to point in the opposite direction.

This week’s highlight is Tuesday’s release of December consumer price inflation figures. Could these record a larger-than-expected drop in the headline rate, or will inflation prove stickier? This may further entrench market views regarding the next Fed rate increase, but Fed speakers, including Powell, Harker and Bullard later this week, might reset any optimism regarding limits on monetary policy tightening. The USD is on the defensive, based on the macroeconomic picture, but interest rates can still offer support, in my view.

Central banks – emerging market central banks can’t continue to tighten as aggressively, can they?

Last week there was little to peak the market’s interest, with only the National Bank of Poland announcing on interest rates, and they decided to keep interest rates on hold. 

The bigger question for this year is whether central banks around the world can, or even should, continue to tighten monetary policy aggressively from here on out. The news on inflation appears to be improving, the gas supply shortage no longer appears as pressing, and economic output looks to be slowing quickly.

In the coming weeks there will be a number of key emerging market central bank decisions. I suspect that we will see either a softening of the decisions themselves, or in the language being used for future policy decisions, which could prompt some additional currency weakness in the short term, in my view. 

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