United Kingdom: What’s the Bank of England’s strategy?

Last week’s UK data releases were unimpressive from an activity perspective, with the monthly Gross Domestic Product figures recording a smaller rise in February versus expectations – thanks largely to weaker industrial production and construction output. The British Retail Consortium’s March retail sales figures fell 0.4% year-on-year, a sign that inflation might be beginning to bite on discretionary spending. The labour market figures recorded a smaller increase in employees on payroll in March (and a big downward revision to February’s numbers). While employment rose by just 10,000 in the three months to February versus the previous three months. The Royal Institution of Chartered Surveyors’ house price balance in March fell to 74% of surveyors seeing prices rising, down from 78% in February.   

The inflation figures on the other hand overshot market consensus forecasts for consumer prices, retail prices and producer prices (both input and output) in March. The increase in raw material and energy prices were the crucial factors driving prices higher, but clothing and footwear, household goods and restaurant and hotel prices also rose sharply.

So how will the Bank of England deal with this? The rise in inflation is likely to tempt a few of the Monetary Policy Committee (MPC) members to keep sanctioning rate increases, but the signs that the economy is perhaps starting to slow will concern other members. It is difficult to see how the current strategy of rate increases will deal with the inflation overshoot and it may prompt a larger undershoot in years to come, in my opinion. 

The key releases this week are the Growth from Knowledge consumer confidence index for April; the March retail sales volumes data and the provisional April Purchasing Managers’ Index (PMI) survey data for manufacturing and services. If consumer confidence continues to drop, if retail sales are under additional pressure and if the PMIs show signs of a slowing in activity, this may heighten the concern amongst the MPC that going too far too fast will damage the recovery, or worse put it into reverse gear. For the GBP, I think the risks are growing to the downside. Against the USD, last week saw tests through $1.30 and a limited ability to recover. Against the EUR, the moves higher through €1.21 looked unconvincing. I wonder whether the GBP might be a big underperformer this week, if the data and surveys don’t go its way?

United States: US Fed Beige Book won’t unpick rate hike expectations

The US Federal Reserve will, in all likelihood, hike interest rates by 50 basis points in early May – and there was nothing to dissuade the Fed in the data and surveys from last week. There were overshoots from the March US consumer and producer price inflation figures, albeit from the former the overshoot was only the headline rate, with the core Consumer Price Index rate rising less than the market consensus forecast. Retail sales grew slightly more than expected (excluding auto sales), industrial production rose by more than double what was expected in March, and most of the surveys on consumers or businesses beat consensus forecasts also. The one exception came from the small business optimism index for March, which fell to its lowest reading since April 2020, at the height of the pandemic’s first wave. 

As a consequence, the US dollar continued to enjoy a rally last week, reaching fresh highs on an index basis, having already topped those in the early stages of this week. The USD’s rise has been built on the back of the weakening Japanese yen predominantly, but the continued tests on the downside for the GBP and EUR suggested broader overall strength. If the Fed do hike aggressively in May, and signal further significant and swift hikes to come, that could propel the USD even higher. However, are the various regional Reserve Banks witnessing any divergence?

This week’s Beige Book will hopefully illuminate the financial markets. It’s clear that the housing market is seeing a slowdown in demand, with a consistent drop in the numbers of new mortgage applications over the course of the past few months, but on its own that is likely to be insufficient to stop the US central bank from tightening. Unless there are clear signs from other areas of the US economy that the rise in borrowing costs already seen, coupled with the inflation on necessity goods, are undermining activity, the Fed looks as if it will lift interest rate significantly higher by early summer.

There will be some interest in the March housing starts data, released on Tuesday, March existing home sales figures on Wednesday, April Philly Fed business outlook index on Thursday and then the preliminary April manufacturing and services PMIs on Friday. These are likely to re-affirm that the economy is, at this point, strong. As such yields and the US dollar could rise further over the remainder of this week.

Europe: Euro still under pressure; ECB emphasises growth risks over inflation

Last week wasn’t a bad week for economic data and surveys. The two key releases were the April Zentrum für Europäische Wirtschaftsforschung survey (Germany’s sentiment index), which fell by less than was expected on both the current situation and expectations indices, and then the Italian industrial production figures for February, which rose by far more than forecast – up 4%, four times the Bloomberg consensus. 

However, the EUR fell sharply following the European Central Bank (ECB) Governing Council meeting. The statement accompanying the decision to leave policy unchanged emphasised that the outlook was becoming more uncertain, with greater upside risks to the outlook for inflation, but downside risks to growth. In fact, the ECB regarded the downside growth risks as more troubling than the inflation risks. This put the EUR into a bit of a tailspin, pushing it back towards recent multi-month lows, below $1.08 against the USD and above €1.21 against the GBP. 

This week’s highlights amongst the raft of data and surveys include the Euroland consumer confidence index for April and the preliminary April manufacturing and services PMI indices. Will these record a further slowing in Euroland activity and a drop in confidence? In all likelihood, yes, which could further undermine the EUR. After the drop in the EUR after the surprise from last week’s ECB meeting, I don’t believe it would take much to drive EUR/USD to fresh lows. And the recovery in the EUR, which has appeared less and less convincing with every fresh sell off, looks ever more distant, in my opinion.

Central Banks: Israel and RBNZ hike by more than expected; China cuts unexpectedly; BoI and PBOC this week

Last week’s central bank decisions from the Bank of Israel and Reserve Bank of New Zealand  (RBNZ) were both more than what had been expected by the financial markets. The Bank of Israel hiked its base rate by 25 basis points – when only 15bps had been expected. While the RBNZ hiked by 50, rather than 25 basis points. The Bank of Canada hiked by 50bps, but the markets had priced for that, and the Bank of Korea hiked as expected by 0.25 percentage points to 1.5%. The big surprise though was that the People’s Bank of China (PBOC) cut the required reserve ratio for banks to 11.25% from 11.5%. That was a smaller move than had been expected, suggesting that, even in China, concerns about the economy are balanced with concerns over the outlook for inflation. 

The Bank of Indonesia aren’t expected to move interest rates this week, and the PBOC may follow up the action last Friday with a small cut to 1-year and 5-year prime loan rates. They might also do more in terms of cutting the required reserve ratios. Given the lack of movement from the renminbi, there is room to do more without spooking the FX markets, in my view.


See last week’s FX Outlook.

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