United Kingdom

Economic signals continue to worsen; Gross Domestic Product, credit and house prices the focus for this week

Last week saw consumer price inflation figures released for May. The headline rate increased again, rising to 9.1% year-on-year from 9% in April, but core Consumer Price Index (CPI) inflation fell to 5.9% year-on-year from 6.2%. Producer price inflation data reported much larger than expected increases in input and output prices in May. The inflation figures were one of the few supportive releases as far as the Bank of England’s recent decision to raise interest rates was concerned.

The remaining releases were much less optimistic. Rightmove house prices rose just 0.3% month-on-month in June, and the annual rate slipped from 10.2% to 9.7%. The Confederation of British Industry (CBI) industrial trends and distributive trades surveys both recorded a worsening in June versus May, with activity down and, from an industrial perspective, prices down as well. The Growth from Knowledge (GfK) consumer confidence reading for June fell to a new record low, as consumers worried not only about the general state of the economy but also about their own financial positions. Finally, the May retail sales figures recorded a fall in sales volumes, after a far less impressive rebound in April. Revisions saw sales broadly unchanged over the two months. Notably also though, food store sales took a hit, household goods sales were down again, and internet sales dropped after posting a fleeting recovery back in April.

So the data and surveys are still, in large majority, pointing to the probability of a negative quarter of growth in Q2, in my view. Over this week, there are important releases from the UK in terms of final Q1 economic output, June/Q2 house prices from Nationwide and May consumer lending from the Bank of England. The final Q1 Gross Domestic Product (GDP) figures should record no revision to 0.8% quarter-on-quarter growth reported in Q1, house price growth is set to slow in June, and May unsecured consumer lending is set to grow by £1.3bn on a net basis, according to Bloomberg market consensus. 

Risks are for the data and surveys to indicate additional weakness, which in turn could undermine the latest rebound in the GBP, at least against the USD, in my view. The direction for GBPEUR is less clear, with the figures from Euroland in the past week disappointing against market consensus expectations, and making the macroeconomic picture less clear for FX markets to trade off, in my opinion.

United States

Fed Chair Jerome Powell indicates the tightening will continue despite further signs of economic downturn

The US Federal Reserve Chairman, Jerome Powell, gave a clear signal to markets in his testimony before the Senate Banking and House Financial Services Committees. He indicated that nothing is off the table as far as monetary tightening is concerned, and appeared to indicate that another 75 basis point hike could be agreed at the July meeting, after exactly that magnitude of tightening was agreed in June. Comments from St Louis Fed President James Bullard, suggested that he was relaxed about the pressures on the consumer or the prospects of recession. However, the data does not support Bullard’s position, in my opinion.

Indeed, last week showed some further signs that the outlook for the US was worsening, with a drop in May in existing home sales and a new record low reached in the final June University of Michigan consumer sentiment survey, outweighing a surprise surge in May in new home sales. 

This week sees a limited data calendar in terms of big releases. There should be plenty of interest in the June Conference Board consumer confidence index released on Tuesday, to see whether this falls to bring it more into line with the University of Michigan consumer sentiment outturns. If there remains a significant difference, then Wednesday’s release of personal income and spending figures for May, coupled with the final Q1 GDP figures are likely to be the markets next port of call. Spending is holding up well on a nominal basis, but real spending could show the first signs of decline. If there is any sign also that activity was weaker than previously estimated that would add to the indications that the economy is weakening. On Friday, the final June manufacturing Purchasing Managers Index (PMI) and June manufacturing Institute for Supply Management (ISM) indices are expected to report a drop in both, but equally both are still pointing to expansion, even if it is a much slower one.

As we approach the end of the second quarter, the US dollar is set to close out the period significantly higher (roughly 6%) than where it opened. So there are few warning signs yet suggesting that there is any pressure to bear on the US dollar against other majors, especially with the likes of USDJPY hitting fresh multi-decade highs in the past week. I think there could be some more US dollar strength to come in the early part of Q3, but perhaps the vast bulk of dollar strength is now priced in? Equity markets look to be closing out a difficult quarter in better spirits, but is that because markets are beginning to doubt whether the economy will be able to withstand the rate hikes?

Europe

No easy choices for the European Central Bank as the surveys tank again

The last week wasn’t a great one in terms of economic data and surveys from the Euroland economy. At the beginning of the week, Euroland construction output figures for April recorded a 1.1% month-on-month decline. That was followed by Dutch and Euroland June consumer confidence reporting renewed declines, which overshadowed a rise in Belgian and Irish consumer confidence. There was then a much larger than expected decline in the preliminary June manufacturing and services PMI indices. The services reading fell to its lowest level since January 2022, but the January reading was due to renewed lockdowns and restrictions, so the slump in the services reading now is more troubling, in my view. Finally, the German IFO* business climate index fell to 92.3 in its June outturn, with the expectations component falling unexpectedly, and that was followed up by Italian consumer confidence, which fell to 98.3, its lowest reading since 2020 and the second wave of pandemic infections and lockdowns. 

The European Central Bank may still be considering a large, 50 basis point, interest rate hike come its 21 July Governing Council meeting, and given that the Swiss National Bank have hiked by that amount recently, it is still the risk in my mind. However, given the weakness of the economic data and surveys lately, such a hike or even a 25 basis point hike, is not a forgone conclusion. The poor performance of the economy contrasts sharply with the inflation overshoot and weakness of the euro (against the US dollar), both of which would argue for greater tightening. 

As for this week’s data and surveys, the focus will be on inflation figures from Germany, France and the Euroland aggregate for June. These are all expected to report a further jump in inflation rates, but could there be a surprise from one or more of these releases in terms of inflation not meeting the market consensus expectations? As far as the euro is concerned, the significance of interest rate spreads cannot be overstated. These may close in the euro’s favour, against the pound and US dollar, with expectations for UK and US tightening still drastically overstated, in my view.

* Information and Forschung (research)

Central banks

Iceland and Czech Republic hike by more; will this week’s hikes help with inflation?

Last week’s central bank meetings included Iceland and the Czech Republic, both of whom hiked by more than the markets were pricing for. Icelandic official interest rates rose to 4.75% from 3.75%, the highest level they have been since 2017, comfortably above the pre-COVID pandemic levels. Furthermore, the Governor stated they would hike by a further full percentage point if needed. The Czech central bank hiked 125 basis points to 7%, but two members of the committee voted against raising interest rates any further. Later in the week there were hikes from the Philippines and Mexico, with a larger than expected hike from the Norges Bank, who hiked rates to 1.25% from 0.75%. 

This week sees the central banks of Hungary, Colombia and Sweden all meet, and the expectation is that the central banks will hike significantly again, Hungary by 50 basis points, Colombia by 125 basis points and the Riksbank by 50 basis points. The central banks are all concerned by the rise in inflation, but the question is whether what they are doing will work without substantial economic pain. Take Hungary for example: the forint continues to weaken, inflation continues to rise and consumer and business confidence are in a tailspin. Is the remedy to collapse the economy, and if so will it actually bring inflation into check?