After the celebrations of the Queen’s Platinum Jubilee has come the hangover. Financial markets began this week with the knowledge that a confidence vote in the PM, Boris Johnson, had been triggered by at least 54 MPs writing letters to the 1922 committee withdrawing their confidence in his leadership. The vote, held at 6pm on Monday (6 June), saw the PM win, but not decisively, with more than 40% of MPs indicating they had no confidence in the PM. Boris Johnson will have a difficult job in convincing his MPs and constituencies that he can reassert his authority on policy direction to their satisfaction, in my view.

Financial markets initially saw the GBP rally on the back of this news, the GBP rally driven by hope that a change in leadership in the government would inspire greater (unspecified) certainty around policy, rather than any short-term improvement in the current economic conditions or outlook. The rally in the GBP has not lasted after the vote though and has, in my opinion, also been driven by the weakness in the USD, which I explore later on.

For this week, aside from the political uncertainty, there aren’t a lot of issues to focus on as far as the financial markets are concerned – at least not in the UK. There will be interest in the May British Retail Consortium sales monitor and final May reading of the services PMI (Purchasing Managers’ Index) on Tuesday, the construction PMI index for May on Wednesday, and the May Royal Institution of Chartered Surveyors house price balance on Thursday. That said, even if there is an additional worsening in these indicators, suggesting that the UK faces tough times ahead, that might not be sufficient to prompt any change from the central bank.

It appears we are heading for another 25 basis point rate increase at the June Monetary Policy Committee meeting, due to be held in under two weeks from now, and the concern over the pick-up in inflation is increasing rather than reducing. The markets have built back in a peak in UK interest rates of over 2.75%, something that I believe would significantly add to the woes already being faced by consumers and businesses. 

For the FX markets, it may be time to focus on the economy, and not on interest rate expectations, which are becoming increasingly unrealistic in my opinion.

First and foremost, the 390,000 net-new jobs added (according to May non-farm payrolls data released at the end of last week) did little to help the US dollar, which is experiencing a further hiccup after hitting new highs in the first half of Q2. The labour market report came at the end of the week when the data and surveys were very mixed. There was additional strength in house prices, albeit that was for Q1, and a lot has changed since then. There was some surprising strength in the Chicago PMI in May and the Conference Board consumer confidence index, also for May, but then a further reduction in mortgage applications.

In terms of the labour market report, the rise in the unemployment and underemployment rates were at odds with the strength of payrolls growth, so suggests that the pace of labour market improvement may have slowed or cooled altogether. There was a drop in average earnings growth as well, and net-earnings remain deeply in negative territory. There were also some further small negative revisions to the figures from the previous two months.

What about this week? US consumer credit figures for April (Tuesday 7 June) are expected to show credit is still elevated – again most likely because credit cards are not being paid off, rather than because of the strength of spending. Mortgage applications could dip further in the latest week, but it is the end of the week that holds the greatest interest. May consumer prices and the provisional June University of Michigan consumer sentiment reading could provide additional concern for the financial markets. Consumer price inflation is expected to dip on the core measure but hold firm at 8.3% year-on-year on the headline basis, whilst consumer confidence could decline to fresh lows. 

Meanwhile the Federal Reserve appears to be readying itself for another 50 basis point rate increase, something that will, in my opinion, add to the pressures being felt by homeowners and consumers, and potentially accelerating the decline in the US economy. That won’t, in my view, help the US dollar against the other majors, as we have seen it underperform lately as the interest rate differentials have narrowed between the US and the UK and Euroland.

Last week’s releases saw Euroland inflation hit a fresh high of 8.1% year-on-year in May, French Q1 Gross Domestic Product figures revised to a 0.2% quarter-on-quarter fall, French April consumer spending figures dramatically underperform consensus expectations and disappointment from the Euroland PMIs, with the composite index falling slightly in the final May reading versus the provisional one.

All in all, the figures from Euroland were disappointing at best, and certainly unsupportive, outside of the inflation figures, of a significant change to the monetary policy stance. That didn’t stop the EUR consolidating its recent gains against the USD and GBP however.

The European Central Bank (ECB) is, according to the Financial Times, preparing a new package to help relieve any state that finds itself on the wrong end of a debt market sell off. That is coming at the same time as the financial markets are increasingly convinced that the ECB will signal an impending interest rate increase. Can the ECB manage to prevent yields rising sharply at the same time as it is raising interest rates? I am sceptical, given that yields have risen sharply over the course of the past few months even while the Pandemic Emergency Purchase Programme (PEPP) has been in action, and the ECB’s scope for any market intervention will be limited. 

The ECB meeting on Thursday is the key event of this week, but there are also some interesting Euroland releases due. Tuesday sees the release of the June Euroland Sentix investor confidence index and the April factory orders data from Germany. Wednesday sees German April industrial production data and the revised Euroland Q1 GDP figures, whilst Friday sees the April Italian industrial production figures released. Could the confidence index recover a little further? Will production weaken or strengthen, and will any of this help the EUR?

Whilst the data and surveys might be interesting, the markets interpretation of what the ECB actually does will prove most important in terms of the direction of travel for the EUR. In my opinion, there is a greater resistance to further EUR gains, and the risks are to the downside against the USD. Versus the GBP, the risks are more balanced, albeit that I see there being a closing in the gap between UK and EUR interest rate differentials that could work in the EUR’s favour.

Last week Hungary’s central bank hiked interest rates to 5.9% from 5.4%, in line with expectations and to the highest rate since November 2012. The hike was in part driven by the ongoing inflation problem, but also because of the weakness of the Hungarian Forint, which remains close to record lows against the EUR. The Bank of Canada also hiked rates by 50 basis points to 1.5%, despite weakness in Q1 economic growth, this time entirely because of the building inflation concerns at the central bank. It also warned that the interest rate moves could be more forceful if needed and saw the peak in Canadian interest rates reaching or even breaching 3%.

For this week, things begin with the Reserve Bank of Australia, that is expected to hike rates to 0.6% first thing on Tuesday, the central bank of Chile is then expected to hike interest rates past 9% later that day, and the Reserve Bank of India is forecast to hike the repurchase rate to 4.8% from 4.4% on Wednesday. Later that day we should see the National Bank of Poland hiking by 75 basis points to 6% and finally, on Friday, the central bank of Peru should hike by 50 basis points to 5.5%. All the central banks remain concerned about inflation, but with the Polish central bank there will be additional concern about the weakness of the zloty. The only central bank currently materially cutting interest rates is the Russian central bank, and the key rate could fall to 10% at the end of the week as the ruble continues to strengthen.