The last week was all about the Bank of England (BoE) decision, but prior to it there were some data and survey releases which continued to indicate that the impact of higher inflation and higher interest rates was beginning to bite. There was a further slide in the pace of new car registrations in April; March lending to individuals data reported a sharp increase in the level of borrowing secured on dwellings; shop prices rose by the largest amount year-on-year for almost 11 years; and the Purchasing Managers’ Index (PMI) data reported increases in the manufacturing and services PMIs from provisional April readings and a smaller drop in the construction PMI index versus consensus forecasts.

When the BoE delivered its decision and latest verdict on the outlook for the UK economy and inflation, there were plenty of surprises. The vote was the first surprise, swinging 6-3 in favour of a 25 basis point rate increase, with all three dissenters (Mann, Saunders and Haskel) voting for a larger 50 basis point increase. The BoE then signalled that at least two members indicated that the BoE should hike no further (likely to include Cunliffe and Tenreyro). Other, and possibly more damning, revelations  were the latest projections for inflation and growth. Inflation is forecast to reach a short-term peak of 10% later this year, before slipping back sharply. Based on market-implied interest rates, the inflation rate will however significantly undershoot its target at the three-year forecast horizon, and by more than seen in the February projection. Furthermore, growth is set to contract in 2023, albeit modestly in the latest Gross Domestic Product projection.

The financial markets swiftly unwound a chunk of interest rate hike projections, following the BoE decision. GBP resumed its drop, having rallied briefly after the Federal Reserve’s decision earlier in the week. GBP dropped beneath $1.23, and against the euro it fell below €1.17, the lowest it has been in almost five months. 

For this week it is difficult to see what will support any sustained recovery in the GBP against the USD. While against the EUR there is some risk that, based on the prospect of further hawkish statements from European Central Bank (ECB) members, an additional drop might be forthcoming. In terms of the UK data releases, the UK Q1 GDP figures released on Thursday hold centre stage for financial markets. Can growth top 1% quarter-on-quarter or will it fall short? What momentum is being carried through into Q2 from the March monthly figures and what will the split between industry and services look like? Other than that the cupboard is relatively bare. Although there will undoubtedly be interest in the British Retail Consortium’s April like-for-like retail sales values data, released first thing on Tuesday.

What else could the Federal Reserve have done last week? There had been suggestions from some quarters that they could raise the targeted Fed Funds rate by three quarters of a percentage point. But Fed Chair Jay Powell indicated that they hadn’t seriously considered this. That, at least temporarily, upset the US dollar, which dropped in the immediate aftermath of the decision. That said, the Federal Reserve did not close the door to aggressive tightening in total in order to control inflation, and did not appear too concerned about a downturn in economic activity either. The markets didn’t really downgrade interest rate tightening expectations, with interest rates expected to reach 3% by the end of Q1 2023, barely changed from recent highs.

In terms of last week’s release calendar, there were some signs of weakness in the Institute for Supply Management readings in April for manufacturing and services, a smaller number of job openings based on data from Job Openings and Labor Turnover Survey in March, a surprise rise in job cuts in April according to Challenger and a rise in weekly jobless claims. However, all that was window dressing for the main event – the April employment report from the Bureau of Labor Statistics. This reported that there had been an additional 428,000 net-new payrolls added in April, slightly more than had been expected, but labour force participation slipped back and the underemployment rate rose unexpectedly. The markets paid little attention to the news, but the signs are perhaps growing that employers are scaling back hiring intentions in the face of higher costs.

The US dollar still managed to make new highs last week, with the dollar index rising briefly above 104, its highest level since Q4 2002. However, notably against the euro it struggled to make additional headway and ended the week marginally higher than it had begun the week. 

For this week, consumer and producer price inflation data is likely to be the centre of attention for financial markets. The April data is predicted to record a decline in headline and core inflation rates, which would come as a welcome relief to authorities who have witnessed a vast overshoot versus target. The figures though might disappoint consensus expectations, which would, in my opinion, prompt a renewed rally in the USD against other majors as it would likely further embed expectations of significant additional monetary tightening from the Federal Reserve.

There were more comments from ECB officials last week suggesting that the Governing Council are getting closer to sanctioning a monetary tightening at some point this year. The Finnish central bank Governor, Olli Rehn, indicated that the ECB should raise interest rates in July, whilst Austrian central bank Governor Robert Holzmann stated that a July hike would be discussed. There is no consensus for a hike in July, but the markets are steadily coming to the conclusion that a hike will be forthcoming at some point in the coming months, in my view. 

Last week saw a further slide in most confidence measures, including a big drop in Euroland economic and consumer confidence indices for April. Economic confidence hit a 13-month low, whilst consumer confidence hit a two-year low, when the global economy was at its most uncertain due to the pandemic. There really wasn't much good news from the Euroland economy last week, with industrial production from Germany and France slipping in March, the former reporting a drop of 3.5% year-on-year, compared to a rise of 3.1% year-on-year in February. 

So, while some ECB officials would like to raise interest rates, there is, in my view, insufficient evidence to support the case for a hike over the next couple of meetings. Already this week, the Euroland Sentix investor confidence index for May has recorded a further drop to -22.6, a reading worse than any other seen since June 2020. There remains a clear dichotomy between inflation and activity, and the central bank will have to pick which one it fears most.

In the remainder of this week, the Germany’s sentiment index (Zentrum für Europäische Wirtschaftsforschung) survey for May is most likely the key release that markets will focus on. This could also record a further worsening in both the current situation and expectations indices, which is unlikely to prove helpful for any sustained EUR recovery, in my view. It is notable though that the EUR has performed strongly against the GBP in the last week, suggesting that the markets are more worried about the UK outlook, than Europe’s. Can the EUR sustain its gains against the GBP, which have propelled GBP-EUR to multi-month lows?

Last week’s action started with the Icelandic central bank agreeing a 100 basis point increase in interest rates to 3.75%, taking interest rates to the highest level since mid-2019. The Reserve Bank of India also hiked interest rates to 4.4% from 4% previously, citing concern over the rupee’s weakness and inflation rates. Following that there was a 1 percentage point increase in the Selic rate from the Brazilian central bank, taking interest rates to 12.75%; the Czech central bank hiked 75 basis points, more than had been expected; the Polish Monetary Policy Committee hiked by 75 basis points, although 100bps had been priced in; and the Colombian central bank hiked 125 basis points. All in all, the concerns over inflation in Eastern Europe, Asia, Scandinavia and Latin America appear to be growing, and the monetary responses seem to be becoming more, rather than less, severe. 

This week sees the central banks of Romania, Malaysia, Mexico and Peru all due to announce decisions on monetary policy. The Romanian central bank could deviate again from the standard 25 basis point hike schedule, and hike again by 50 basis points to 3.5%. The National Bank of Malaysia aren’t expected to hike, but may offer a warning about inflation creeping into the economy. Banxico (Mexico) are expected to hike by 50 basis points, but could they do more? The inflation numbers are challenging in Mexico and in Peru, so the Peruvian central bank has an even greater risk of tightening by more than 50 basis points, as it tries to get on top of the inflation challenge as it sees it.