The UK economy appears to be slowing. The Q1 March Gross Domestic Product (GDP) figures released towards the end of last week made that abundantly clear, with services and industrial output dropping unexpectedly in March and a larger than forecast trade deficit. However, the Q1 GDP growth figure was still healthy - up 0.8% quarter-on-quarter and below the 1% expected, but still a solid outturn. As for the other limited releases, the British Retail Consortium like-for-like sales figures for April recorded a sharper than expected drop in sales values, although the figures may have been distorted because of base effects associated with the 2021 re-opening of non-essential retail.

Bank of England Deputy Governor, Dave Ramsden, thought further interest rate hikes would be necessary to control inflation in the medium term. There is undoubtedly short-term pressure on pricing because of supply chain disruption and labour market shortages, but I suspect these will pale in comparison to the UK economic risks that are growing to the downside.

The pound took another significant hit against the USD and EUR, falling to as low as $1.2156 and €1.1603 - the latter being the lowest level traded since September 2021, in the midst of the short UK fuel crisis. The markets did improve towards the end of the week, but the rebound in the GBP against the major currencies has thus far been fairly unimpressive. 

For this week, there are a lot of important UK data and survey releases. The calendar begins with Tuesday’s labour market data for March and April. These should record stable unemployment conditions, weaker employment and limited average earnings growth. On Wednesday, the consumer price inflation figures for April are expected to report a fresh peak in headline and core consumer price inflation for the UK, with the headline rate expected to climb to 9% year-on-year, from 7% previously. However, the markets should be more interested in the releases on Friday. First up is the Growth from Knowledge consumer confidence index for May. UK consumer confidence readings are already at recession levels, but could they fall to fresh lows, levels not seen since the survey began? As for April retail sales volumes data, released a few hours later, these are predicted to show volumes dropping again in April, after a sharp drop in March. 

The rebound in risk appetite seen on Friday of last week will be tested over the course of this week. I’m not convinced that the markets are yet at a stage to produce a sustained recovery, and the risks to the pound remain to the downside for this week and the weeks that follow. The pressure on authorities to tackle the downturn in activity is set to grow, in my opinion, which could initially intensify the threat to the GBP in the short term, but provide a base for it to rally from in the longer term.

Last week’s economic data and surveys from the US weren’t particularly mind-blowing, but did highlight the problem for central banks all over again. The middle of the week saw a less steep decline in Consumer Price Index (CPI) inflation rate than had been expected. April headline inflation was 8.3% year-on-year (down from 8.5% in March), whilst the core rate fell to 6.2% from 6.5%. The contrast though was the weekly jobless claims figures, which reported another modest rise, and University of Michigan consumer sentiment index for May, which slid to fresh 13-year lows, a drop far greater than the markets had anticipated. 

Federal Reserve Chair, Jerome Powell, attempted to cool market expectations about where US interest rates might be heading. After a confirmation hearing before the Senate, Mr Powell’s remarks at a press conference indicated that the Federal Reserve couldn’t guarantee a soft-landing for the economy, but that acting more aggressively at the May meeting would not necessarily have made much difference. So, it appears to me the Federal Reserve are still set to sanction an additional 50 basis point rate increases for now, but are wary of the damage such moves could make to the US economy in the longer term. 

For this week, the main focus for markets will likely be around retail sales and industrial production data for April - both of which are expected to report ongoing increases in sales values and industrial output. Could the data come in weaker than expected though, and what about manufacturing and business surveys for May? Moreover, the housing market data for April and May released on Tuesday, Wednesday and Thursday this week could report a more significant slowing in activity rates, in my opinion.

Based on some further economic weakening, the interest rate markets could continue to come off the boil, in terms of what they are pricing in for US interest rates, and that could filter into some additional USD strength in the early part of the week. It may be difficult though for the markets to make fresh highs for the USD index, and maintain those highs, given how far and how quickly markets have adjusted over recent weeks. One notable benefit of the USD’s recent gains is that it ought to put a lid on inflation, in comparison to what’s happening in Euroland and the UK.

The short answer to that question is yes. Last week’s data and survey releases showed that the Euroland economy has limited momentum in terms of activity rates. After a weaker start from the Euroland Sentix investor confidence index for May, there was a slightly better than expected outturn from the expectations index of the May German ZEW* survey, contrasting with a slightly worse than expected current situation index. The Euroland industrial production figures for March recorded a slightly smaller drop in output than consensus forecasts, albeit that February output was revised lower, so the net impact was about the same. For the European Central Bank (ECB though, the risks of a greater inflation overshoot have risen, as the EUR has continued to drop against the USD. Comments from ECB officials last week, and at the beginning of this week would suggest they are looking to tighten monetary policy over the coming months, starting most likely in Q3, in my opinion. However, whilst the inflation risks are growing, so also, in my view, are the downside risks to economic activity. 

We have already had the European Commission Spring forecasts for growth released this week. These showed that the EU will grow 2.7% in 2022 and 2.3% in 2023, down from 4% and 2.7% predicted in the Winter forecast published in February. Inflation is set to be higher, and if there are more severe issues that emerge, for example regarding gas supplies from Russia, that could bring activity to a virtual standstill in 2022. I think that 2023 forecasts are optimistic, with downside risks to growth more obvious than any recovery prospects, in my opinion. 

In the remainder of the week, French unemployment data for Q1, revised Q1 GDP figures for Euroland, final April consumer price inflation data for Euroland and provisional May consumer confidence data, also for Euroland, are set to be the key releases for markets to focus on. The data won’t offer a huge amount for markets to move on, given much of the data is revisions on preliminary outturns, but the consumer confidence reading at the end of the week could undershoot market consensus forecasts. If it does, then the recent improvement in risk sentiment, seen towards the end of last week could, in my opinion, evaporate as quickly as it appeared.

In terms of the EUR, its performance has been disappointing once again versus the US dollar, but the lows of 2017 have so far acted as support. Should EUR-USD fall beneath $1.0341, the risks are a move to parity, in my opinion, and even below there. With the ECB becoming more hawkish, the reasons for EUR to continue to underperform appear to be dissipating, however. 

*ZEW, Zentrum für Europäische Wirtschaftsforschung, Germany’s Sentiment Index

Last week’s central bank meetings were expected to deliver a series of rate increases, but the week started with a surprise as the National Bank of Malaysia (BNM) hiked the overnight rate to 2% from 1.75% - the first hike since January 2018. A recovery from the pandemic and elevated commodity drove the decision, with another hike expected in the second half of 2022. The Romanian central bank had hiked slightly more than expected (75bps versus 50bps expected) prior to the BNM’s move, but that was less of a surprise than what the Malaysian rate setters sanctioned. Later in the week, the Mexican and Peruvian central bank heads also hiked interest rates to 7% and 5% respectively, as the challenges of inflation remained pressing on central bank policymakers.

For this week the central bank calendar is light. The central bank decisions of the Philippines and South Africa are the only ones of interest. A hike of 25 basis points is expected by the central bank of the Philippines, with the risk of a greater move given the larger than expected rise in inflation seen recently. As for the South African Reserve Bank, a 50 basis point hike is expected, albeit that move is driven as much by concerns over the weakness of the rand as the increase in inflation, albeit South African CPI inflation is still running well short of inflation rates in developed economies. Will higher rates prevent a further rand depreciation?