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Services inflation becomes a possible floor for GBP

Opinion polls continue to point to the opposition Labour Party winning a sizeable majority at the 4 July UK General Election. Such an outcome isn’t expected to have a meaningful impact on Sterling given the (likely) modest macro outlook and constrained public finances. But no battle plan survives the first contact with the enemy and elections are often no different. For Sterling, the market’s focus appears more on Threadneedle Street than Downing Street.

  

Stickier than expected services inflation led markets to dial back expectations for a June rate cut, which now looks very unlikely, to the benefit of Sterling. Our UK team holds their expectations for the Bank of England (BoE) to cut interest rates at their August meeting, but will now only deliver 0.75% of easing in 2024 (compared with their previous expectations of 1% of interest rate cuts). To my mind, this may have put a floor on further Sterling weakness. Taken together with news of overseas takeover interest in UK assets, the near-term outlook for Sterling may be brighter than some had previously envisioned, in my view. But FX is a relative asset class and developments in the US and euro area could affect current levels.

 

Expecting a June interest rate cut in Europe

With the European Central Bank (ECB) on course to ease interest rates at their upcoming June meeting, the focus this week will be on euro area consumer price inflation (CPI) and European regional data releases. To my mind, markets will not look to Friday’s CPI data release to confirm a June rate cut, as ECB Governing Council members have all but done that already. Instead, the focus may be on what Friday’s CPI number means for the interest rate outlook beyond June’s meeting, in my view.

 

Thus far, ECB Governing Council members have refrained from giving clear guidance beyond a June rate cut. NatWest’s European economics team expects euro area headline CPI to tick up to 2.6% year on year in May from 2.4% in April. Core inflation is expected to remain broadly unchanged at 2.7%. To my mind, a realisation of these forecasts may not move the needle in either direction. EUR/USD may consolidate at current levels. Watch out also for Italian confidence and German business survey indicators released in the second half of the week.

 

Focus on personal consumption in the US

It’s a light US data calendar this week with the highlights coming on Thursday and Friday where we will get US GDP, initial jobless claims, and the Personal Consumption Expenditure (PCE) index deflator, the Fed’s preferred measure of inflation. Our US economics team expect the core PCE deflator to have advanced by 0.2% in April, which would follow back-to-back gains of 0.3% in March and February and a hefty 0.5% spike in January. Even so, a downwards shift in line with their expectations is unlikely to provide enough confidence for the Fed that inflation is back on a sustainable path to 2%. But, in my view, markets are fairly well priced for this outcome.

 

 

For more NatWest insights into FX markets, listen to the Currency Exchange.

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