Last week’s see-saw action in asset markets hasn’t yet rubbed-off onto currency markets, but the GBP is likely to be vulnerable if the falls, seen in UK yields towards the end of last week, are sustained and exceed those seen in the US and Euroland.
United Kingdom: Are the UK’s problems just beginning?
That is the likely risk, in my opinion, since the UK economy is more vulnerable to the real- term drop in household disposable incomes than its counterparts in the US and Euroland. A larger proportion of the UK economy is consumer-focused, and the UK’s recovery was driven by a sharp improvement in household spending in 2021.
Last week’s data and surveys recorded more of a slowdown in the pace of employment but a rise in wage inflation in December, higher consumer and retail price inflation and a rebound in retail sales volumes in January. However, the final data release on retailing was revealing, as retail sales only recouped about half the fall seen in December, and a series of downward revisions to the data left volumes lower overall.
This week has already seen the release of preliminary February manufacturing and services Purchasing Managers’ Index (PMI) data. The market consensus was for a hike in the services PMI, but a small slowdown in manufacturing activity. The outturns were better than expected, with the services outturn materially up to 60.8 from 54.1 in January, which was the highest reading since June 2021. That, after a sharp rise in house prices in February, as recorded by Rightmove, gave the week a positive kickstart.
In the remainder of the week, the UK releases January public finances figures on Tuesday (22 Feb), along with the February Confederation of British Industry (CBI) industrial trends survey. On Thursday the CBI releases its February distributive trades survey and first thing on Friday sees the Growth from Knowledge consumer confidence survey for February released. These data and survey releases are expected to record some slowing in the progress of the UK recovery and possibly some weakening of consumer confidence. If the news in aggregate is bad, then the risks are to the downside for the GBP.
However, the biggest potential risk for the GBP could come from the Bank of England’s Treasury Select Committee testimony, due on Wednesday. If the Bank of England re-issue statements suggest that the market is overpricing the interest rate hike risks, then that could prompt a renewed drop in the GBP’s value, with GBP/USD struggling to hold above $1.3650 and GBP/EUR struggling to climb back above €1.20. If, on the other hand, those testifying express greater concerns over the inflation outlook, then GBP may build on recent gains. Much like the weather affecting the UK over the course of the second half of last week, there could more volatile conditions ahead for the economy, asset markets and FX over the next few weeks.
United States: US economic data outperforms but surveys disappoint
The US economy continues to perform strongly, on the surface at least, but the risks are to the downside (as far as growth is concerned) as we get deeper into 2022, in my opinion. Last week’s raft of releases included: retail sales, industrial production and existing home sales all for January, which significantly outperformed market expectations; retail sales bouncing almost twice as much as expected (3.8% month-on-month versus 2% consensus); and industrial production almost three times market consensus (1.4% month-on-month vs 0.5%). The jump in existing home sales was particularly surprising, given the rise in mortgage rates, which hit a multi-year high last week, and contrasted starkly with housing starts, which fell sharply in January.
Surveys were weaker than expected, continuing the theme from the previous week’s slump in consumer sentiment. The Empire manufacturing and Philly Fed business outlook surveys reported underperformance against consensus and a drop in the index respectively, showing that there may be harder yards to be won in the remainder of this year.
Federal Reserve speakers last week suggested that there was a sufficient case to argue for tightening in March but disagreed on the scale of the hike needed. Will the Fed attempt to pull the trigger on a bigger hike in March whilst arguing that going early means doing less tightening overall? Whatever route the Fed choose, there will have to be a very carefully worded statement to go alongside it to ensure there are no misinterpretations!
This week’s data calendar has fewer big releases due, although there will be interest in the manufacturing and services PMIs for February released on Tuesday, just ahead of the Conference Board’s February consumer confidence index. These surveys are likely to conflict a little but risks are to the downside on both, I think. Later in the week, revised Q4 Gross Domestic Product figures, January personal income and spending data and the University of Michigan’s final February consumer sentiment survey are also expected to have downside risks attached. These releases are all window dressing in the run-up to the following week’s releases of the Fed Beige Book of current economic conditions and the February non-farm payrolls data. Watch out for an additional plunge in US yields if the data and surveys underperform, which could prove a short-term support to the USD.
Europe: European Central Bank heading towards policy normalisation, but very slowly
The story of last week from the Euroland economy was one of greater overshoots on inflation, a more modest improvement in Germany’s sentiment index, Zentrum für Europäische Wirtschaftsforschung survey in February versus consensus forecasts, and a surprisingly large improvement in Euroland industrial production in December. So, once again the news was mixed, and yields fell back a bit in the second half of last week.
Perhaps the more interesting developments came from European Central Bank (ECB) Governing Council members’ comments. These generally synched with ECB President Christine Lagarde, who had suggested in previous weeks that the ECB would be looking for the right time to withdraw the stimulus to the Euroland economy and then, at some point beyond that, start to hike interest rates. From the likes of Rehn, Visco, Villeroy, Kazaks and Kazimir was a very consistent message that the bond buying programme would end in the summer. However, they all stressed that tightening too early could undermine the recovery, a point emphasised by the Chief Economist, Philip Lane. Prepare for a hike this year, but don’t overprice the number or size of them, was what they appeared to be saying with one voice.
This week has already seen a bounce in the services PMI in preliminary February results, but the manufacturing index recorded a slight slowing in activity because of weakness in Germany. For the remainder of the week, the attention is likely to be on Tuesday’s German business climate index for February from Information and Forschung (IFO), Germany’s Institute for Economic Research and then the Euroland confidence indicators at the end of the week. An improvement is expected in these, but might we see underperformance versus expectations?
The EUR needs a solid base from which to rally. Thus far in 2022 the data and surveys haven’t provided that, but the big improvement in services activity bodes well for beyond Q1 and a rapidly accelerating recovery, in my view. As such, it might not yet be time to signal the rally in the EUR has begun, but we appear to be a lot closer to that point, judging by recent data and survey releases.
Central banks: All on hold last week; Hungary and New Zealand set to hike this week
Last week’s central bank meetings were few and far between, and interest rates were left on hold by both the central banks of the Philippines (where rates remained at 2%) and Turkey (14%). There seems little room for manoeuvre for either central bank at this juncture, with both economies grappling with the Covid recovery, which is causing some inflation pressures, but also growth problems.
For this week, the central bank meetings kick off with the Bank of Israel. They are expected to leave interest rates on hold at 0.1%. Tuesday sees the central bank of Hungary announce, and a hike of 50 basis points is expected by the markets. Following swiftly on from that, the Reserve Bank of New Zealand announcement early on Wednesday morning should see the cash rate rise to 1% from 0.75%, although there might be a risk of a 50bps hike given the jump in inflation seen recently. Finally, on Thursday, the Bank of Korea should leave policy unchanged, waiting until later in the year to resume the tightening cycle, once the economy has had time to further recover. The Bank of Korea will be watching developments in the inflation rate with concern though, which could bring forward the timing of the next hike if inflation overshoots expectations.
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