United Kingdom

GBP stands on the cliff edge as the data, surveys and reports all worsen

Last week’s batch of surveys, data and reports painted a bleak picture for the UK economy, with only one exception. The British Retail Consortium’s shop price index for June reported the highest increase in shop prices since 2008, with food prices rising sharply and creating a large proportion of the pressure on household incomes. There was also a report by the Joseph Rowntree Foundation, which had surveyed a large number of low income households to see what changes they were making to weekly budgets. It was clear that a majority of households were forced into making changes, but in many cases they were having to cut back on essentials and discretionary purchases given the rise in prices.

Later in the week, Nationwide house prices reported a slowing in the pace of annual house price growth, and following on from that the PMI (Purchasing Managers’ Index) manufacturing survey reported a virtual stagnation in output. There was nothing in the final June PMI report to be optimistic about. The only release that performed better than expected was the Bank of England consumer lending report for May, which showed less pressure on unsecured consumer lending, and ongoing strength from the housing market.  

 Reports in the media suggested that the government was mulling a cut to VAT (Value Added Tax). Albeit that the cut was unlikely to be more than 2.5 percentage points, and will only offer limited help to household budgets given that food is exempt from VAT. Will the cut in VAT work? Looking at the last time a temporary VAT cut was introduced, back in 2009 during the global financial crisis, there was evidence it wasn’t fully passed on and limited evidence it led to an increase in spending. Moreover, already this week we’ve had another report on the cost of living crisis, this time from think tank The Resolution Foundation, and it suggests the efforts of the government in trying to ease the pressures on low income households have been only partly successful.

The GBP was under pressure again last week, and that despite BoE (Bank of England) Governor, Andrew Bailey, saying that a larger interest rate increase was still on the table in the eyes of the Monetary Policy Committee. I doubt that would improve relations between the government and the Bank of England should the central bank under Bailey’s stewardship seek to tighten more aggressively. Furthermore, the pound would likely come under additional pressure were the BoE to hike by more, given how quickly the UK macro situation appears to be worsening. GBPUSD could test recent lows over the course of this week, and GBPEUR might come under renewed pressure also, even with the raft of BoE speakers due over the course of the week. I suspect there will be more reports of the squeeze on incomes and its effects on the discretionary spending behaviours of consumers, as well as some important US releases that will keep the pound under pressure.

United States

Cracks appear in US consumer spending; GDP revised down; Fed doubles down on inflation threat

 Do central bankers really think they can engineer a soft landing for the US economy? Federal Reserve Chair, Jerome Powell, certainly thinks so, but in any case he is more worried about the threat of inflation to the US’s medium term macroeconomic outlook, and suggested in remarks last week that the Fed would consider hiking by 100 basis points if conditions warranted such action. The financial markets weren’t convinced by Powell’s hawkishness, with those doubts fuelled by a few data releases that undershot expectations and indicated that things weren’t as rosy as the Fed Chair was trying to suggest.  

In particular, the Q1 GDP figures reported a weakening of consumer spending and a downward revision to Q1 GDP, making the contraction larger than it was initially reported to be. Subsequent to that, May personal spending data was weaker than expected, recording a drop in real terms of 0.4% month-on-month, leaving real personal spending lower than where it was in March. The manufacturing ISM (Institute for Supply Management) index was weaker than expected, with the new order and employment components both suggesting a contraction in orders and the labour force. Finally, on Friday, the vehicle sales data for June recorded a much less impressive recovery in vehicle sales in June, suggest consumer attitudes to big ticket item spending has significantly reduced.

For this week, the big release is clearly the June non-farm payrolls data on Friday. The US labour market is indicating a weakening in conditions, albeit that the figures remain positive in terms of net payroll gains. The same is true for June, albeit that the rise in payrolls is set to be one of the weakest outturns we’ve seen since the rebound began back in mid-2020. If the US labour market does record a sharp slowing in the pace of jobs growth, this will be another element of the US economy that the Fed will have to choose to ignore if it wants to continue with its plan to keep raising interest rates.

 As for the USD, it remains strong on a USD index basis and I would suspect that the gains it made over the course of Q2 will provide stiff resistance to any counter attack from the likes of the EUR, GBP or JPY. There is nothing in the batch of data releases from the US this week to support any significant gains in the dollar, but I think risk appetite will take another nosedive at some point, prompted by the ongoing worsening in the general economic environment.

Europe

Euroland inflation surges despite surprise German fall; sentiment and industrial production to worsen?

 Euroland economic data was a bit of a mixed bag again last week. The June inflation figures from Germany, France, Italy and the Euroland composite were the obvious big releases and recorded significantly different outturns. German inflation recorded a surprise drop in its CPI (Consumer Price Index) inflation rate, to 8.2% in June from 8.7% year-on-year. France’s CPI inflation rate rose to 6.5% from 5.8% year-on-year, but that was in line with expectations. But Italy’s CPI inflation rate significantly overshot expectations, rising to 8.5% from 7.3% year-on-year. It was this that was in part responsible for the Euroland CPI inflation rate rising more than expected, to 8.6% from 8.1% previously, and with oil and gas prices having climbed again in the second half of June, that could propel inflation to greater heights in July, in my opinion.

 Last week also saw weaker consumer confidence in Germany (July), France and Euroland (June), and though there were some better-than-expected outturns for economic and services confidence from the Euroland measures released with the June Euroland consumer confidence data, the markets were in no mood to give the EUR the benefit of the doubt. It fell against the USD, at one point dipping to $1.0366, close to mid-May lows of $1.0350. Although the EUR has bounced from these lows, it looks pretty unimpressive, in my view, and the threat to the EUR is that the generally weak risk appetite environment will continue to drag it down in the short term, even as we approach the next European Central Bank (ECB) meeting where interest rates are set to increase.

 This week has already kicked off with the July Sentix investor confidence index from Euroland. The news wasn’t good, with the index falling to a fresh low since the height of the pandemic at -26.4. That weakness was taken in stride by markets though, as they were too busy listening to ECB speakers Muller and Vasle, both of whom hinted at significant tightening to come over Q3/Q4. That has led to a jump in Euroland yields and offered support to the EUR, when the underlying macro picture would suggest such strength is unwarranted, but not unwanted by the ECB.

  In the remainder of the week, industrial orders and production data are released for May from France, Germany and Italy. Will production have been damaged by the rise in prices, or are the factories still playing catch up? Figures from Spain, already released, would suggest more the latter rather than the former, but Portuguese production data suggests the exact opposite. So are we in for another week of inconclusive data and survey releases?

Ater the EUR performed poorly last week against USD, is it in for any significant recovery? It performed better against the GBP until the very end of the week so there is potential for some EUR strength, but in my view it will be more evident against the GBP, because the UK economy is beset by economic issues, rather than against the USD, where the economy is still performing solidly.

Central Banks

Hungary and Sweden ramp up the hikes; Reserve Bank of Australia and National Bank of Poland in the spotlight this week

Concerns over inflation and currency weakness drove the National Bank of Hungary to hike interest rates by 185 basis points to 7.75% last week, the highest level Hungarian official interest rates have been at since August 2009. The rise in interest rates helped the forint to pull back from record weakness against the EUR and USD, but only marginally, and the HUF is likely to remain under pressure, in my view. The Riksbank also raised interest rates last week, delivering a 0.5 percentage point hike to take Swedish rates to the highest level seen since June 2014. Inflation was seen as the key driving force behind the Riksbank’s action, but I suspect the Riksbank will have taken some cue from the action of the Norges Bank a week prior. There was also a 150 basis point hike from the Colombian central bank, taking interest rates in that part of Latin America to their highest level since the end of 2016. There appears to be further hikes likely from these central banks over the coming months, but will we see the economies struggling during that period?

For this week, the focus will be on the decisions of the RBA (Reserve Bank of Australia), early on 5 July, and the NBP (National Bank of Poland) on 7 July. The RBA is expected to hike the cash target rate a further 0.5 percentage point to 1.35%, whilst the NBP is predicted to hike to 6.75% from 6%. The NBP could hike by more, given concerns over the zloty, which remains weak, albeit not as weak as it was in early March. There are also decisions from the Bank of Israel, National Bank of Malaysia, and the central bank of Romania, all of whom are also expected to hike interest rates based on the inflation challenge. Again the question is, how much will economies be allowed to weaken in the fight against inflation?