For market sentiment, we’ve seen extraordinary swings in yields, with the markets moving from pricing-in more than six rate increases (of 25 basis points each) in UK interest rates over the next 12 months, to fewer than five, and back to more than six again. The huge increase in energy prices, and further surge in other commodity prices, clearly has weighed on the minds of market participants, and though the short-term outlook for interest rates appears to be clear, in the longer term the trade-off between inflation and activity means any judgement is far harder to make.

Last week saw January activity data come in far stronger than expected. GDP growth was 0.8% month-on-month against expectations of just 0.1% growth; industrial production rose 0.7% versus 0.1% expected; and services activity rose 0.8% versus a 0.2% consensus forecast. However, whilst activity was up, the trade deficit deteriorated significantly, to a record £16.1bn in January – more than double the previous record. Finally, inflation expectations also rose significantly in March, with the Bank of England/Ipsos measure for the next 12 months rising from 3.2% to 4.3%.

For this week, the attention is on Wednesday’s February consumer price inflation figures, and Tuesday’s labour market data for January. But will either of these really influence the Bank of England’s decision on monetary policy on Thursday? I suspect not, even if there are ongoing signs of strength in headline and core consumer price inflation, or a further increase in average earnings growth. The Bank of England are expected to hike interest rates by 25 basis points, but even if they do there will be a lot of interest in the way the committee voted, and what concerns, if any, they have about the threats to activity from the Ukraine conflict and rise in energy and raw material costs.

As for the GBP, there is some potential upside against both the USD and EUR, but it is difficult to see what would sustain the rallies even in the short term. Levels that will provide increasing degrees of resistance are $1.3220 and 1.3350 in GBP/USD, and €1.1955 and €1.1980 in GBP/EUR. I still believe that the risks are for a break lower in both currency pairs, prompted by significant downward revisions to the number and frequency of UK rate rises that the markets currently price in. GBP, for the time being, is at the bottom of recent ranges against both the USD and EUR. 

The latest consumer price inflation data from the US recorded the headline rate reaching 7.9% year-on-year and the core rate rising to 6.4% – fresh multi-decade highs for US inflation. This rise in inflation was even higher before the latest surge in energy and raw material costs. These cost rises could see inflation rates moving into double digits within the next few months. Meanwhile in other releases seen last week: the number of employees quitting jobs remains elevated; the number of job openings recorded a fresh high; and consumer confidence continued to decline.

It is that last point that I think is being taken too lightly by monetary authorities, including the Federal Reserve. The rise in inflation has undisputedly been from supply-side factors, none of which are controllable from a central bank’s perspective. The argument that the Fed are trying to prevent slippage into second-round price effects also works off the assumption of economic strength that hasn’t been backed-up by the consumer or business sentiment surveys. If consumer sentiment continues to slip, there will come a big correction in the activity data which, though it shouldn’t, will take the Fed by surprise. Attempting to engineer a soft landing once a downturn is underway is all but impossible, in my opinion.

This week’s Federal Reserve meeting and decision on Wednesday evening, will be at 18:00GMT because the clocks in the US go forward this weekend whilst UK clocks don’t adjust for a further two weeks. The decision should be a 25-basis point hike in the targeted Fed Funds rate, taking the upper bound to 0.5%. What will the Fed have to say in its statement regarding the short to medium-term macroeconomic risks facing the US economy more broadly than the short-term spikes in inflation rates? They should perhaps pay attention to the fact that, whilst not every recession is preceded by a 50% increase in oil prices, every time oil prices have increased by 50% or more, a recession has followed!

US yields pressed higher towards the end of last week, but the driver of the US dollar appears to be the volatile geopolitical situation in Eastern Europe, which continues to drive investors back towards return of capital, rather than return on it. Note however that the US government is again attempting to break the blockage as far as a longer fiscal funding deal is concerned. The latest deal would finance the government beyond the November mid-terms and also include billions in support for Ukraine.

I remain of the opinion that the European Central Bank (ECB) aren’t convinced that conditions yet warrant the need for monetary tightening in 2022, and that’s despite a further overshoot of the inflation rates in the February releases. The Governing Council meeting last week did agree to wind down the asset purchase programme faster, such that the ECB should not be buying any assets by the end of Q3. This gives the ECB time to hike before the end of the year, if required, but equally compels them to no strategy either way.

The data and surveys last week weren’t exactly informative either. Strength in German industrial orders and production in January contrasted with weakness in Spanish, Irish, Italian and Dutch industrial production. Meanwhile, the Euroland Sentix investor confidence index for March recorded a far sharper fall in the index than expected, falling to its lowest level since November 2020 as fears of the effects of the conflict on economic activity and market risk weighed.

This week’s big releases from Euroland include the German sentiment index survey (ZEW, Zentrum für Europäische Wirtschaftsforschung) for March, on Tuesday, and the final February Euroland consumer price inflation figures. The ZEW may well see a sharp dip in the expectations index although that appears to already be priced-in to consensus expectations. So perhaps the numbers actually beat expectations? As for inflation, the overshoot on a headline basis is expected to have worsened, the only question is by how much?

As for the EUR, with authorities still unwilling to commit to rate increases and with the possibility of more countries being dragged into the conflict, the risks are still to the downside for the EUR. But there is perhaps not as much risk as there was at the beginning of the war. The EUR can perhaps hold up better, now that it has already moved several percentage points lower against the USD.

Last week saw the National Bank of Poland (NBP) hike interest rates by 75 basis points, slightly more than the central expectations. But it was notable that the NBP’s main concern was the sharp sell-off in the Polish zloty, which could add to the country’s woes in terms of imported inflation pressures. The hike to 3.5% takes interest rates to their highest level since early in 2013, and there remains the risk that, despite downside risks to activity, the central bank will keep on hiking. The central bank of Peru also hiked interest rates, but this time by 50 basis points, with concerns over inflation paramount to this central bank. Peruvian interest rates at 4% are only at a 4-year high, but the authorities in Peru remain concerned that inflation will remain elevated until H2 2023, and perhaps might require further efforts to suppress it.

This week we have the meetings of the Brazilian Central Bank (BCB), Bank of Indonesia, central bank of Turkey, Taiwanese central bank, Russian central bank and Bank of Japan. The central banks of Indonesia, Turkey, Taiwan and Japan aren’t expected to adjust policy, and given the emergency hike from the Russian central bank, neither should they. So, the interest really lies with what the Brazilian Central Bank do. Expectations are for a 1% point hike in rates, but the BCB have had a recent habit of doing more, so don’t be too surprised if they hike 1.25% or even 1.5%. Inflation is well above target levels, and despite the risks of a global economic slowdown, those at the sharp end of monetary policy strategy are more worried about putting the inflation genie back in the bottle currently, in my view.