Last week saw the pound come under renewed pressure against the USD, falling below $1.30 for the first time in 15 months but bouncing back against the EUR, briefly rising back above €1.20. The moves seemed to be driven by heightened concerns over geopolitics in eastern Europe, increased expectations of US interest rate hikes, and further signals from the Bank of England that the risks to the economy are both potential downside risks to growth and also upside risks to inflation, and as such the monetary policy path is much less certain.

Notably, last week saw yields rise in the UK, with the markets now pricing in UK interest rates above 2% by the end of the year – something that I still find troubling given the poor performance of some parts of the UK economy, particularly the weakness in consumer confidence. Already this week, the UK February Gross Domestic Product figures recorded weakness in activity, with construction output and industrial production significantly worse than expected. Whilst services output held up, the outlook looks increasingly challenging.

For the remainder of this week, the UK releases include labour market data for February, consumer, retail and producer prices for March, and the March RICS house price survey. The labour market data is expected to report a substantial improvement in employment after the falls recorded in December and January, but more attention is likely to be placed on average earnings growth. Is that continuing to pick up, and if so, what is the gap between earnings and inflation? The March inflation data is expected to record significant additional increases in the inflation rates across the board. These should culminate in a peak being reached in April, when the energy price cap hikes take hold. As for the Royal Institution of Chartered Surveyors house price survey, the balance of surveyors expect prices to decline, albeit that estate agents continue to report poor supply across the regions.

In my view, the GBP’s decline is unlikely to be maintained this week against the USD. The pound has dropped sharply, but then so have other currencies against the USD. The markets are unlikely to sustain the pace of USD gains and could give some of them back in the absence of any material changes to the economic or geopolitical conditions. Medium-term risks for the GBP still lie to the downside, in my view, but just not this week.
 

The last week saw little of note for release from Euroland. The April Sentix investor confidence index fell more sharply than expected and the data on German factory orders and industrial production recorded additional signs of deterioration in February. Overall, the figures did nothing to shake the undercurrent in markets of EUR weakening, which culminated in a multi-week low in EUR/USD at the end of the week.

Meanwhile, European Central Bank (ECB) officials were busy speaking. In particular, Chief Economist Philip Lane indicated that the Governing Council were mindful of risks to both sides of the economic outlook and would be in no hurry to raise interest rates until the uncertainty reduced. ECB President Christine Lagarde may have to take some time off from official duties, as it was announced towards the end of last week that she had tested positive for Covid.

For this week, inflation and activity surveys precede the ECB Governing Council meeting on Thursday. German inflation rose to 7.6% in the preliminary March reading, and is not expected to be revised higher, but that may be the risk. Germany’s sentiment index, ZEW (Zentrum für Europäische Wirtschaftsforschung), for April is predicted to record a further drop, with expectations falling from the -39.3 reading in March to -48.5 (and perhaps in excess of -50). If it fell beyond -50 that would represent a worse outturn than the one seen immediately after the onset of the pandemic. The ECB are set to make no material changes to policy or to the tone of their language. Indeed, the inflation picture has worsened, but then so has the economic outlook. French and Italian consumer price index inflation figures on Friday (after the ECB decision) aren’t expected to cast any additional light on the challenge facing the central bank.

As for the EUR, it is under pressure but just about holding-off of making fresh multi-month lows. In the absence of any breakthrough in talks between Ukraine and Russia, the concern must be that, with commodity prices remaining elevated and the US Fed on alert to hike interest rates aggressively, the underperformance will continue for some time to come.
 

The situation in the US economy remains mixed. Last week saw the factory orders data record a decline in February, although that just reversed part of January’s bounce and notably was the first reduction in US factory orders since April ’21. Mortgage applications continued a steady decline, down 6.3% week-on-week, and numbers at their lowest level since March 2019. On the flip side, the Institute for Supply Management services index rose in March after the decline in February, jobless claims fell to their joint lowest weekly reading since records began and consumer credit exploded in February, net credit up $41.8bn, with revolving credit figures potentially indicating a drop in the amount of credit consumers are paying down.

The USD managed to climb above the 100 mark on the dollar index, a level that it hadn’t been above since May 2020. The rise in the USD is being driven by heightened expectations that the Federal Reserve will be aggressive with monetary tightening, something that was given additional impetus by Fed members, including Bostic and Evans, but culminating in St Louis Fed President Bullard arguing for US interest rates to rise to 3-3.25% by the end of the year. There is probably further for the USD to go, albeit that the rise from here is likely to prove trickier to hold on to given the rally already seen (the USD index is already up 4% since the beginning of January and 8% over the past year).

For this week, the focus will return to the data. Consumer price inflation figures for March are released on Tuesday, with the headline rate expected to hit almost 8.5% and the core rate rising further beyond 6.5% year-on-year. March retail sales figures will also be interesting to watch. This is a value-based series, so will spending increase month-on-month by more than the rise in prices? And if not, how severe will the drop in volumes be? Also released at the end of the week are University of Michigan consumer sentiment figures, the Empire manufacturing survey for April and March industrial production data. Consumer confidence is predicted to decline but the Empire manufacturing survey and industrial production figures should show improvements to counterbalance this.

The USD can make some additional headway this week, but I would be surprised to see it give back some of its recent gains against other majors. After the end of the quarter, which saw the USD make impressive gains, a step backwards may prove necessary before it can move forwards again, in my view.
 

Last week’s central bank calendar kicked off with no change from the Reserve Bank of Australia (RBA), followed by a 50 basis point hike from Romania. Both of those decisions were expected, although the RBA hinted at an earlier return to monetary tightening, which prompted a sharp rally in the AUD. The central bank decision that really interested markets was the Polish central bank, who increased interest rates a full percentage point, to 4.5%, citing higher inflation risks from the war in Ukraine and currency risks as the key drivers. More could be coming in terms of interest rate hikes in the short term, before a peak in inflation is found. But are the medium-term risks that inflation undershoots as the downturn in the economy takes hold? Later in the week, the central bank of Peru raised interest rates 50 basis points to 4.5%, the Reserve Bank of India left policy on hold, and the central bank of Sri Lanka hiked interest rates from 7.5% to 14.5%, as protests grew in the region.

This week, the Bank of Israel are expected to hike interest rates by 15 basis points, signalling the beginning of its tightening cycle. The Reserve Bank of New Zealand are forecast to hike a further 25 basis points, to 1.25%. The Bank of Canada is expected to hike interest rates by 50 basis points to 1%, and finally the Bank of Korea is predicted to hike rates to 1.5% from 1.25%. Could any of the central banks hike by more? Possibly, but unlikely, in my view.

See last week’s FX Outlook.