The economic picture clouds over as US debt ceiling negotiations and UK data releases take centre stage. This week sees crunch talks take place between the negotiating teams of President Biden and Speaker McCarthy to try and break the impasse on the US debt ceiling issue. There are still some important differences between the two sides over spending and regulatory reforms, and both sides are still trying to position this as a win for them. 

From a market perspective, it is more important that a deal which would avert a government shutdown and a potential default on US government debt gets done, rather than who is seen as getting the better end of the bargain. Biden and McCarthy are due to meet on Monday (at the time of writing this has yet to happen), but will anything material come of this meeting, given that reports suggest there has been little movement in either side’s position over the weekend? 

For markets, the risks remain for more volatility and uncertainty, which could undermine recent improvements in the US dollar, or support further recovery dependent on whether a deal is done or not, and what the details of that deal look like.  

Meanwhile, things for the UK pound aren’t likely to be that easy either. The week has begun surprisingly with a sharp increase in house prices, according to Rightmove, with improved demand and still limited supply driving prices higher once more. 

It is data and survey releases later this week that are likely to attract most attention, however, with firstly the provisional May manufacturing and services PMIs (Purchasing Managers' Index) released on Tuesday, consumer, retail and producer price inflation data for April on Wednesday, and then April retail sales volumes due on Friday. These could point to a weakening in economic activity, a sharp drop in headline inflation rates, and only a limited recovery in retail sales. Hardly the backdrop to frame any decision to further increase interest rates, in my opinion, and not one that is likely to offer the GBP much support either. The pound therefore might have to rely on events elsewhere if it is to re-strengthen against the US dollar, and make further headway against the euro.  

As for Euroland, PMIs and the German IFO* for May also hold some interest for financial markets when they aren’t being distracted by the US debt ceiling negotiations. These should also point to a slowing of momentum and a drop in industrial confidence, with French business confidence also likely to drop when it is released this week. 

The data and survey weakness in evidence recently hasn’t blown markets off track in terms of pricing in another European Central Bank rate increase, and nor is it likely to, in my view. Far more is needed in terms of improvements in the inflation outlook, or worsening in the economic outlook, before the ECB (European Central Bank) would consider a pause in interest rate hikes. Even that wouldn’t signal a pause in monetary tightening, as the ECB would still be pushing ahead with the quantitative programme it has embarked on.  

*Information and Forschung / Germany’s Institute for Economic Research

Some central banks believe that further rate hikes will bring inflation down, even given the wealth of information that continues to suggest the vast bulk of inflation is supply side, rather than demand-side led. That should be expected given that the associated economies have significantly above target inflation levels, but this week could see a few surprises. 

The RBNZ (Reserve Bank of New Zealand) and the SARB (South African Reserve Bank) look set to hike interest rates again this week. The RBNZ’s position remains that inflation is too high and interest rate hikes will help bring it down. The SARB’s position is more complex. After recent currency weakness, the hike is likely in response to capital outflows and a currency depreciation, the latter of which won’t help in the SARB’s inflation fight. 

However, the Hungarian central bank could be set to cut interest rates, something that none of the forecasters surveyed by Bloomberg expect to happen. The view from our strategist is that rates could be cut by a full 3 percentage points, front loading the interest rate cuts that would have come at future meetings. Might this prompt a selloff in the forint?