United Kingdom

UK PM Johnson goes; the GBP may be yet to find its lows

The past week has seen a further scandal in UK politics, which ended with the resignation of the Prime Minister, Boris Johnson. For all the toing and froing that went on prior to the announcement, when the resignation actually occurred on Thursday, the markets took it in their stride, with GBP rallying briefly before falling back and finding new lows against the USD. The pound performed better against the EUR, rallying to a six-week high above €1.18, as the euro also came under pressure against the US dollar also. 

There wasn’t much data or survey evidence released from the UK last week, although there was a negative outturn from the June new car registrations which recorded sales down 24.3% year-on-year, having fallen 20.6% year-on-year in May. In units sold, the figure in June was around 3% below the number in June 2020, and around 37% below the 2019 level. There was a marginal improvement in the final June services PMI (Purchasing Managers’ Index) versus the preliminary release, but in terms of market moving events, it was comments from the Bank of England (BoE) Chief Economist, Huw Pill, that drew greatest interest. He stated, at the Qatar Centre for Global Banking, that the Bank of England’s decision would be data dependent, and that there were risks to both sides on monetary policy, and not just a focus on the inflation overshoot. However, financial markets took the comment that the BoE ‘must ensure inflation doesn’t become embedded in the UK’ as a clear signal that the decision was finely balanced between a 25 or 50 basis point rate increase. I think, however, some at the central bank are increasingly uncomfortable with the direction of travel the economy is taking.

For this week, the key releases include the monthly GDP (Gross Domestic Product) figures for May, along with industrial production, construction output, index of services and trade balance data. These could record an additional drop in output, which would make it more unlikely that Q2 GDP output doesn’t record a drop. There is also the June RICS (Royal Institution of Chartered Surveyors) house price balance survey, which is expected to record a further slowing in the pace of house price growth in the latest figures. None of these figures should help the GBP, and the risks are that some of the recent support the GBP has enjoyed versus the EUR reverse over the course of the week, in my opinion.

As for the race to lead the Conservatives and therefore the country, we should get a better insight into who has the support of the party, and therefore what direction might be taken regarding taxes, government spending and growth. I don’t expect it will make all that much difference to the financial markets, in the same way the Johnson’s exit had little impact on markets either.

Europe

Euroland records further slowing in activity; euro slumps to fresh lows

Last week saw the euro plunge to fresh depths against the US dollar. At one point on Friday it was less than 0.75 percentage points away from parity. Although a recovery ensued very late into the end of the week, the downtrend in EURUSD remains intact, and I see few reasons why a full blown test/break of parity won’t occur over the coming weeks. The EUR also performed poorly against the GBP, with EURGBP breaking back below £0.8450.

The activity numbers from Euroland were poor. There was ongoing weakness in the industrial production numbers from Germany, and Italian figures reported a sizeable fall in May, reversing the vast bulk of April’s gains. The final June services PMI from Euroland was marginally revised up, from 52.8 to 53.0, but the drop from May was still significant, and suggests a serious loss of momentum. Higher energy prices are likely to make the economic outlook worse, and that could remain a key driver for financial markets (negative for risk and the EUR in the short term).

For this week, the focus for markets is likely to be on the German ZEW* survey, due for release on Tuesday at 10:00BST. A deterioration in underlying economic conditions should see both the current situation and the expectations indices fall, the only question is how far? If there is a big drop in both of these, that is likely to further weaken the EUR against the USD, in my view, but the outturn versus the GBP is far less certain. 

There are also a few speeches due from the likes of Villeroy, Centeno and Rehn, ahead of next week’s European Central Bank meeting. The markets are still pricing in only marginally more than a 25 basis point rate increase, but could deposit rates be hiked 50 basis points to get them back to zero, at least officially? I think that is still the risk, even if the fundamentals are becoming less and less supportive of such a move. I certainly don’t see logic behind hiking 25 basis points in July and then 50 basis points in September, since it is my opinion that by September economic conditions will have further worsened.

* Zentrum für Europäische Wirtschaftsforschung, Germany’s Sentiment Index

United States

US labour market figures record another solid month of employment gains

The US labour market data on Friday was the release of greatest interest to the financial markets. After the week started on Tuesday, because of the 4 July holiday on Monday, the numbers released ahead of the payrolls data painted a mixed picture of the US economy. May factory orders, and the June services PMI and ISM (Institute of Supply Management) indices were all stronger than expected. But MBA (Mortgage Bankers Association) mortgage applications slipped back, the Challenger job cuts data for June recorded a sharp rise in layoffs year on year, and the jobless claims figures for the week ending 2 July continued the trend of a shallow increase. The payrolls figures were up more than expected, 372,000 versus a consensus forecast of +265,000, but there were downward revisions to May and April figures, which reduced the payrolls total by a net 74,000. The unemployment rate held steady at 3.6%, average earnings growth slipped a little, to 5.1% from 5.3% year-on-year, and the labour force participation rate dropped back unexpectedly.

The effect on markets was for a small increase in yields, equity markets dipped a little initially, and the dollar gave back some of its recent gains, which had propelled the USD index to 107.786 at the end of last week, its highest level since 28 October 2002. The USD is still on an upward trend, and that could be assisted this week by releases that could argue for higher US interest rates than markets are already pricing in.

In particular, Tuesday’s June consumer price inflation figures are in the spotlight. The consensus is for a rise to 8.8% year-on-year. On a headline basis something that, if superseded by the outturn, would prompt additional speculation of how much the Fed will increase at its upcoming July FOMC (Federal Open Market Committee) meeting. The Beige Book for that meeting is also released on Wednesday this week, as well as June retail sales and industrial production data, and provisional July University of Michigan consumer sentiment. What happens if inflation strengthens but activity/confidence continues to weaken? Which side does the Fed want to reverse the most? 

Central banks

Hikes ahead

Last week saw more hikes from the likes of the Bank of Israel, the Reserve Bank of Australia, National Bank of Malaysia, the Romanian central bank, the National Bank of Poland and the central bank of Peru. There were some surprises in the decision making, with the Romanian central bank hiking more than expected, to 4.75% from 3.75%. But the National Bank of Poland hiked by only 50 basis points, when the market favoured a 75 basis point hike. The zloty came under pressure immediately after the central bank decision, although it seems to have now stabilised, despite some dovish comments from National Bank of Poland Governor Glapinski. Romania’s hike was driven by a worsening inflation outlook, and Governor Isarescu indicated that more could be forthcoming. The Reserve Bank of Australia’s 50 basis point hike in rates was also driven by a worsening inflation outlook, but arguably the data and surveys are beginning to point to a material worsening in Australia’s economy. 

For this week, the Reserve Bank of New Zealand, Bank of Canada, Bank of Korea and central bank of Chile all meet. All of the central bank decisions come with a risk that the central banks will step up the tightening pace, albeit that most of the economies face a deterioration in economic conditions. The Reserve Bank of New Zealand and Bank of Korea should hike by 50bps, the Bank of Canada by 75bps, and the Chilean central bank by 100bps. The warning signs for domestic and global growth aren’t yet strong enough to prevent these central banks from stepping up the pace, but could impact on future decisions. What will the impact be on the currencies? I’m not convinced rate hikes will be helpful to these currencies, given that it is likely to weaken the growth further.