The past week was light in terms of releases of updated economic indicators, but those which were released painted a damning picture of current conditions. House prices continued to rise, according to Rightmove, but the rise was far less significant according to the Nationwide Building Society, with prices rising the slowest amount since the end of summer 2021. Meanwhile Confederation of British Industry (CBI) indicators on industrial activity recorded a larger than expected drop in business confidence in Q2 (the lowest reading since the pandemic outbreak), and a much slower pace of total orders expansion in April versus March. The CBI also released its April distributive trades survey, which also recorded a sharp fall in reported sales volumes, perhaps the first signs of a slump in discretionary spending prompted by significant inflation pressures.

Market interest rate expectations fell sharply over the course of last week. By the end of March 2023 interest rates were predicted to be 2.42%, down from 2.62% a week earlier. These are implied rates, according to Bloomberg, and look materially different to forecasts from economists which suggest a much lower UK interest rate peak. Notably, the current risks of a UK recession over the course of the next couple of years are at 30%, according to the Bloomberg consensus.

This week, the Bank of England’s Monetary Policy Committee vote, decision, quarterly monetary policy report and minutes are the main focal points for markets. Consensus is for a 25 basis point rate increase, with very little dissent from economists about the prospect of either no change or a 50 basis point rate rise. That said, there could be a few surprises in terms of the vote (some members voting for no change, some voting for a larger tightening) and also some sizeable adjustments in the economic and inflation risks from the February quarterly assessment. What might this mean for the GBP, which has been under pressure against the USD lately?

The GBP-USD exchange rate has fallen so far over the course of recent sessions (-3.7% since the open on 21 April) that we may see the pound take a breather or even bounce back over this week, particularly if the Bank of England’s meeting and releases provide some ‘hawkish’ surprises. That said GBP-EUR has not moved much, if at all, suggesting that this move has been predominantly externally driven, and so UK events might not have a lasting impact on GBP valuations.

Last week’s US data was yet another mixed bag. On the positive side, there was another large rise in house prices recorded in February, durable goods orders rose broadly in line with expectations in March, and personal spending rose more than expected in March. However, the list of negative releases was, in my opinion, far more damning. Consumer confidence dropped in April according to the Conference Board’s reading, whilst the University of Michigan reading dropped from initial readings, albeit marginally. Home sales data reported large falls for new and pending sales in March, mortgage applications recorded the largest week-on-week decline in over two months and the lowest reading in over 3 years, and GDP growth fell unexpectedly in Q1, by an annualised 1.4% quarter-on-quarter. 

So, the news was, at least predominantly, questioning the validity of the Federal Reserve’s confidence over the US’s economic performance of the months and quarters to come. It mattered little for the USD, which strengthened significantly versus the euro, pound and yen. Indeed, USD-JPY rose to its highest level in more than 20 years, reaching a high of ¥131.25 at one point last week. On the dollar index (a measure against all major trading currencies) a high of 103.928 was reached, and the last time the dollar index was that high was all the way back in December 2002, so an almost 20-year high. Is it time for a pause for thought though, given that the USD now appears to be moving almost independently of other financial markets, geopolitical or global macroeconomic risks?

This week, the centre of attention is Wednesday’s Federal Reserve monetary policy meeting. The Federal Open Market Committee are set to raise interest rates by 50 basis points to 1%, a follow-up to the initial 25 basis point tightening authorised in March. This decision appears straightforward, but some members of the Fed want to hike more quickly, worried about letting inflation get out of control. In my opinion, I don’t believe the Fed’s actions will prove helpful in controlling inflation, but will almost certainly destabilise the recovery.

The Fed might not be interested in watching the mortgage applications data from the US, but the financial media are picking up on what’s happening. An article on Bloomberg noted the sharp decline in mortgage applications, something that we have highlighted for several months. These figures are, in all likelihood, going to continue to report a decline in applications over the course of the coming weeks and months, which may start to influence markets and the Feds thinking more. However, for this week the April non-farm payrolls will draw the markets attention, post the Fed’s decision. The payrolls data is expected to record a sizeable circa 400,000 net increase in payrolls, with another drop in the unemployment rate, to 3.5% from 3.6%, and solid average earnings growth of around 5.5% year-on-year expected. I think the risks around this release are to the downside, and as such there could be some pull back in recent USD gains. Risk appetite might bounce back after the sharp sell-off at the end of last week, giving the US dollar additional cause for pause.

Last week’s start was positive, with a surprise improvement in the German IFO* business climate index for April. The increase in the reading was marginal, and came after a few months’ worth of sharper falls. So, by no means was this a reason to sound the all clear on the German economy, but it was encouraging nonetheless. The mood quickly turned sour though, as consumer confidence readings in Germany, France, Italy and Portugal fell, with all but the Italian reading undershooting market consensus forecasts. Spanish unemployment also rose unexpectedly in Q1, the rate increasing to 13.65% from 13.33% in Q4.  While Q1 GDP growth from Euroland was an unimpressive 0.2% quarter-on-quarter, albeit that considerably outperformed the US Q1 GDP outturn. 

There was also a lot of interest in the April estimates of consumer price inflation. German and French figures rose more than consensus expectations, to 7.8% and 5.4% year-on-year respectively, but the Spanish inflation rate fell more than expected to 8.4% year-on-year, down from almost 10% in March. The Euroland aggregate Consumer Price Index inflation rate held at 7.5% year-on-year in April, but the core inflation rate also increased by more than consensus forecasts (3.2%) to 3.5% year-on-year, increasing the pressure on the European Central Bank (ECB) to hike interest rates for the first time in over a decade. 

The ECB though are still trying to build a case for a tightening, and that case is being hampered by the weakness of some of the economic data and surveys. Add into that the geopolitical risks, and it is unclear whether the case for a monetary tightening will be clearer over the course of the next couple of meetings. The ECB might choose to tighten monetary policy, but the move would likely be fairly small and would not necessarily signal a series of tightenings to come. The last time the ECB hiked interest rates, back in 2011, proved to be a chastening experience for them, and they will want to avoid being forced into another embarrassing U-turn if possible. 

This week’s main data and survey releases have already seen the German unemployment figures drop less than expected in April. March Euroland producer prices and unemployment figures recorded a larger than expected jump in producer price inflation, while the unemployment rate was 6.8%, in line with consensus forecasts. In the remainder of the week, Euroland sentiment indicators for April could, and in my view will, be weaker than expected. German March factory orders and industrial production data might also indicate enduring problems for the German industrial sector despite the recent Purchasing Managers’ Index survey.

As for the EUR, whilst the challenges remain and we could still see a test of parity against the USD, I suspect the bulk of the weakness is done versus other majors. Even versus the US dollar, I think the EUR might get a breather from the pressure felt over recent weeks. If yields narrow between Euroland and the UK and US, then that could help the EUR find a base. 

*IFO, Information and Forschung, Germany’s Institute for Economic Research

Last week, there were a few central banks meetings due, with some expected to hike interest rates, some expected to cut and a couple expected to do nothing. The meetings kicked off with the central bank of Kazakhstan. It was expected to hike interest rates by 1.5 percentage points, but chose instead to hike by just a third of that. The Bank of Japan was expected to do nothing on interest rates, and duly delivered. But they did implement yield curve targeting, suggesting policy would be looser for longer, which weakened the JPY. The Swedish Riskbank was next, and they surprisingly hiked by 25 basis points, the first hike since the end of 2019, when the Riksbank were raising from a prolonged period of negative interest rates. Finally, the Russian central bank cut interest rates by 300 basis points, when only 200 basis points was expected, as the newfound confidence on the rouble and that the overshoot on inflation was abating, coincided with a significant reduction in Russian GDP. 

This week has already seen the Reserve Bank of Australia raise interest rates by 0.25 percentage points, more than was priced-in, and that should begin a week of significant monetary tightening, in my view. The Brazil central bank is set to raise interest rates by 100 basis points, to 12.75%, the Czech central bank are expected to hike by 50 basis points and the National Bank of Poland are set to hike by 1 percentage point, according to market consensus. Finally, the Chilean central bank may repeat its action of March and hike interest rates a further 150 basis points, but markets are pricing in only a 100 basis point hike. Are the concerns over inflation abating, and if so, what does this mean for future interest rate decisions? Will we see additional pressures brought to bear on the economies where central banks are tightening aggressively? If we do, the risks are that what’s currently priced in as far as future hikes are concerned could be overzealous, and additional volatility in FX might be the result, in my opinion.