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UK August rate cut hopes improve, but will the optimism hold?

The Bank of England (BoE) did what was expected last week and held interest rates at 5.25%. But its statement was where all the action was. Some of those on the Monetary Policy Committee (MPC) who voted for unchanged interest rates (7-2 in favour) saw the decision as finely balanced, and some played down the threat from higher services inflation and the hike in the National Living Wage.

The markets now see an August cut as more likely than not, as well as fully pricing for two cuts of 25 basis points by the end of 2024. Big questions loom. With markets looking at the latest UK General Election polling data and final debates before polling day on the 4 July, will that optimism hold this week? The pound finished last week back towards $1.26, and weakened against the euro following the MPC decision. Will the optimism about UK interest rate cuts continue to undermine the pound, or will there be a reversal of fortunes in interest rate markets (undoing the recent increase in rate cut expectations)?

Politics still in the driving seat in Europe – for now

Elections dominate Europe this week, too. The prospects of the left and right of French politics carving up the lower house of the French parliament gives French President Emmanuel Macron and financial markets something of a headache. The risks of greater fiscal spending in France and a lame duck President for the next two and a half years has widened France bond yield spreads and put pressure on the euro in recent weeks. Will the first round of the French lower house election, held on 30 June, offer another vote of no confidence in the French President, whose popularity has declined steadily since re-election in 2022?

The only data of note from Euroland this week was the release of the June German IFO business climate survey, which was reported early on Monday. That showed additional signs of weakness and offered the EUR no help, in my view.

USD to remain resilient against other currencies

Meanwhile in the US, the Federal Reserve might be feeling the pressure, with data and surveys in recent weeks pointing to additional weakness. The only real exceptions to this have been the May industrial production figures and the provisional June services Purchasing Managers’ Index (PMI) reading, both of which comfortably beat market consensus forecasts. This week’s housing market, consumer confidence and output figures are unlikely to prompt much of a shift in market expectations, in my view. If anything, the data and surveys are likely to help the USD, or at least fend off any recovery from the other major currencies.

More easing expected this week

Global central banking continues to get more interesting, with last week seeing the Swiss National Bank (SNB) deliver its second successive interest rate cut. The policy rate was lowered by a further 25 basis points to 1.25%, but the prospect of additional interest rate cuts is not straightforward: the strength of the Swiss franc and mixed economic signals need equal consideration to any concerns over the recent overshoot of output growth versus consensus forecasts.

This week we are unlikely to see anything other than monetary policy easing – or holding - from those central banks announcing decisions. The Czech Republic and Colombian central banks could cut by 50 basis points each, with inflation within target in the Czech Republic. The only thing that could worry Colombia’s central bank is the weakness of the peso, which has fallen more than 6% since the last interest rate cut. The central banks of the Philippines, Sweden, Turkey and Mexico are not expected to ease.

 

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