Last week was interesting in terms of the message the UK economy conveyed to markets, and the fact that the markets still didn’t really believe it. Firstly, the inflation data pointed to a further overshoot of both the headline and core consumer price inflation rates, albeit that this wasn’t duplicated by the retail price inflation figures. Following on from that were the releases of provisional March manufacturing and services Purchasing Managers’ Indices (PMI), which recorded a slowing in the pace of manufacturing sector expansion but an unexpected acceleration in services sector activity. Finally, Friday saw a further drop in the UK’s consumer confidence reading in March and a surprise drop in February retail sales volumes. This loss of activity in retailing and drop in consumer confidence was, in my view, the most interesting release, indicating that the rise in costs of necessity items was hurting the purchase of discretionary goods.  

Also last week saw the release of the Treasury’s Spring Statement on Wednesday. There was some help to households to mitigate the rise in the cost of living, with a cut to fuel duty, the abolition of value added tax on home insulation and low income households being carved out of the National Insurance hike. 2022 growth was, unsurprisingly, downgraded from previous estimates, to 3.8% from 6%, but that still included business investment growth of 10% for the year. There were also some highly optimistic estimates for 2023 and 2024 growth, but with little explanation of how this growth was likely to be achieved. The Office for Budget Responsibility’s optimism on activity might be the reason why the Chancellor was less generous with the reliefs to the cost of living increases than he might have been and why he didn’t cancel the National Insurance rise. 

Are the Bank of England right to be cautious? In my opinion, absolutely. The potential hit to economic activity from the rise in the cost of living remains an overriding risk versus the further overshoot of inflation versus target in the short term. Attempting to control the rise in inflation with interest rate hikes may prove self-defeating or worse as it may actually undermine growth further without tackling the causes of the inflation, which are predominantly supply side. Other central banks may be more willing to push the envelope in terms of monetary policy tightening, but I doubt they will prove anymore successful in bring inflation back under control.

As for the GBP, its struggle for upside continued last week and is likely to persist this week also, in my opinion. Against the USD the risks are to the downside if the Fed continue to talk tough on tightening or if the geopolitical uncertainty over the invasion of Ukraine persists. On the flip side, a further improvement in risk appetite could help the GBP in the short term, but rallies appear only to attract renewed selling interest currently, in my opinion.

Last week saw several Federal Reserve members speaking about the need for faster monetary tightening, including the Fed Chair Jerome Powell. Mary Daly (a usually more dovish member), James Bullard and Powell indicated that, with inflation continuing to increase, and with little sign of a concerted downturn in activity, a hike of 50 basis points in May could be warranted, or even 50 basis point hikes at both of the next meetings. 

Certainly, with indications of further labour market strength in the latest weekly jobless claims data and strength in the manufacturing and services PMIs, the Fed’s indications appear reasonable. However, the new and pending home sales data for February and the University of Michigan’s consumer sentiment reading showed weakness again, something that should not be ignored. Note that the expectations element of the consumer sentiment figure is at its worst reading since 2011, when economies were still in the grip of the financial crisis. 

For this week the obvious focus is on the US labour market report for March, and specifically the performance of non-farm payrolls employment. Expectations are for further strong growth in employment, with the major constraint remaining a lack of available skilled labour. Will that permeate wage inflation in the latest batch of average earnings numbers, or will we see the rise in consumer price inflation continue to dominate over the rise in earnings, producing a further real reduction in earnings?

The USD has held up reasonably well over recent weeks, despite retreating from recent highs. This week could see it make some renewed headway against other major currencies, in the absence of any materially important data and events from other major economies,  and with the prospect of more strong labour market data from the US. If non-farm payrolls beat expectations again, that will almost certainly support the case for a faster round of monetary tightening from the Federal Reserve, and skew interest rate expectations further in the US dollar’s favour, in my opinion.

Euroland exhibited all of the expected problems from the recent negative shift in geopolitical events on Europe’s border. Consumer confidence indicators all turned far more negative from individual countries, and that culminated in a huge drop in Euroland consumer confidence in March to -18.7, from -8.8 previously. There were a set of better-than-expected provisional March PMI indices for manufacturing and services, but both still fell from readings in February, and the IFO (Information and Forschung, Germany’s institute for economic research) business climate index fell to its lowest level since July 2020. The concerns over fuel and energy supplies, raw material prices, shipping disruptions and order visibility may continue to worsen over the coming months, unless there is a significant improvement in both the geopolitical and Covid situations.  

Indeed, the Euroland economy remains vulnerable to these risks, which may continue to dissuade the European Central Bank from tightening monetary policy much, if at all. The next round of EU economic forecasts isn’t due until late April or early May, and the downgrade to 2023 growth might be of greater interest to markets than any shorter-term growth downgrades, in my view. So, whilst markets still view a hike in the Euroland deposit rate back to zero by the end of the year as likely, I suspect the ECB might tread more cautiously.   

This week’s inflation releases from Germany, France, Italy and, at the end of the week, Euroland are already expected to report an additional overshoot in headline inflation rates in March. The only question is by how much more. Consensus forecasts suggest that the Euroland aggregate rate will rise from 5.8% to 6.7% year-on-year. That’s only a little different from rates in the UK for February, and by the time the UK data for March is published in April, I think it’s likely inflation in the UK will have topped Euroland rates. And that’s despite the Bank of England having already hiked three times.   

The EUR is still struggling for sustainable gains and made little headway against the USD or GBP over the course of the last week. The figures from Euroland inflation this week could prompt additional interest rate hike expectations in the short term, and consequently we could see the EUR make some gains against other majors, but I doubt those gains will prove sustainable. The risk appetite environment remains broadly positive, which is a surprise, especially as the geopolitical risks are more likely to worsen than improve in the near term, in my opinion.

Last week saw further rate increases from the central bank of Hungary, Norges Bank, South African Reserve Bank (SARB) and Banxico. The Hungarian central bank raised interest rates to 4.4%, the highest level since June 2013, with the central bank indicating there were more hikes to come as inflation is set to further overshoot target. The Norges Bank hiked its official interest rate to 0.75% but predicted the peak of interest rates would be 2.5% in 2023, up from the 1.75% projected in December. The SARB raised interest rates to 4.25%, and Banxico to 6.5%, the highest levels since March 2020 for both. With inflation levels predicted to overshoot further, the risks around interest rates for each of the central banks (that announced last week) is for a higher peak. I’m just not convinced it will make much difference to pricing, but it might collapse domestic demand.  

This week sees only the central banks of Chile, the Czech Republic and Colombia expected to hike interest rates. There might be some modest risks of greater hikes than is priced for. Although given that none of the central banks hiked by more last week, the consensus expectations are greater and the threats of higher inflation are now well known, I think those risks are far less significant than in recent months. Chile and Colombia are forecast to hike by a massive 2 and 1.5 percentage points to 7.5% and 5.5% respectively, whilst the Czech interest rate is only predicted to climb by 50 basis points to 5%. Will any central bank start to worry that the downside economic risks are building?

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