USD rallies after bumper payrolls growth and UK Q2 GDP growth is in focus
Bank of England signal limited hikes to come; Q2 GDP is the focus
Last week’s big news was the Bank of England’s (BoE) Monetary Policy Committee meeting for August and the accompanying quarterly economic assessment offered a few insights into the Bank’s current thinking. The central projection for growth in 2022 was revised up, above 6%, and the 2-year inflation projection was revised marginally higher, but the 3-year inflation projection was revised lower. The BoE also indicated that, after a modest hike in UK interest rates, to 0.5%, the focus of attention would be selling down the stock of asset purchases, which is still set to peak at £895bn. There was one dissenting voice amongst the Monetary Policy Committee (MPC), with external member Michael Saunders voting to reduce the asset purchase programme by £45bn.
There were fairly few data or survey releases last week, and those that were released recorded a slowdown in the pace of expansion for the manufacturing, services and construction sectors. The Purchasing Managers' Indexes (PMI) don’t necessarily give a good indication of the month by month activity changes, but it is hardly a surprise that activity rates have slowed once previously closed sectors have fully reopened.
As for the daily coronavirus infections, they finally recorded some renewed increase in infection numbers following the removal of the remaining domestic restrictions. However, the levels of hospitalisations are beginning to reduce, which suggests that the latest upsurge may be coming to an end. The UK government also re-opened more of the travel corridors to countries with lower rates of infection and similar levels of vaccinations.
GBP/EUR rose to a fresh four month high last week, thanks in large part to the weakness of the EUR, rather than any particular strength in the GBP, although the alterations to the forecasts from the BoE could have played some part. Can GBP/EUR rise above the €1.18 area on a sustained basis? Possibly, but it is difficult to see what unexpected domestic impetus there is likely to be.
For this week, all of the interest lies at the end of the week. Then we have the first estimate of UK Q2 GDP, which according to the Bank of England may be as much as 5% Q/Q, slightly more than the consensus forecast of 4.8%. The key driver is set to be the services sector, which re-opened over the course of Q2, with construction and industrial output expected to offer only modest positive contributions. Could that offer the GBP support? Possibly, but the prospects of an overshoot versus consensus aren’t great.
US payrolls show further strength; inflation to record a dip this week?
US non-farm payrolls were the big release of last week. Not only did they beat the market consensus forecasts, but the previous two months of readings were also revised up sizeably. There was a small improvement in the labour force participation rate, but it remains below pre-pandemic levels, by just under 1.5 percentage points. The unemployment rate fell to a new post-pandemic low of 5.4%, whilst average earnings growth rose by more than expected; up 4% Y/Y. The news from the payrolls data means that the number of displaced workers now stands at 5.7m fewer than pre-pandemic levels, but that figure has reduced by just over 4.3m since the beginning of 2021. The ongoing outperformance of the labour market may bring forward any Federal Reserve decision to taper the asset purchase programme, which could come as soon as the next couple of meetings.
Meanwhile, the newswires are reporting that some senior Democratic Senators want to replace the current Fed Chairman, Jerome Powell, with Governor Lael Brainard. The most high-profile supporter of Brainard is Elizabeth Warren, who favours her over Powell because Brainard is viewed as more sympathetic to additional/stricter financial regulation measures versus Powell. Powell though is viewed as more favoured by top aides of Biden, given his response to pandemic and encouragement/support for expansive fiscal policy. The decision is set to be made in the coming months.
For this week, inflation data for July is likely to be the focus for US markets. Consumer price inflation figures are released first on Wednesday, followed by producer price inflation figures on Thursday. The focus for Consumer price index (CPI) inflation should be on the core measure, which has hit multi decade highs over the past few months but is expected to drop back in the July reading. As for producer price inflation, that is also expected to drop back a little, with commodity prices retrenching, although larger falls are expected in 2022. Nothing in these releases is likely to prompt sizeable market moves, but if the core reading for CPI inflation doesn’t fall back, it could lead to higher US yields and a stronger dollar this week, having finished last week stronger also.
Euro struggles for momentum; surveys take centre stage this week
The euro dropped below $1.18 again last week. There weren’t any particular data or survey cues from the Euroland economy, and the only decisive data release from the US came at the end of the week and only served to cement the downward moves already experienced. It is surprising that the euro is under pressure, given that the economy is still most likely to surprise to the topside in terms of consensus expectations for growth versus the US and UK. There has been more pressure on the euro this morning, with GBP/EUR above €1.18 for the first time in 18 months. Neither of these events are likely to be a major concern to the European Central Bank (ECB), but if there were to be additional inflation pressure from non-domestic sources, then currency weakness could become a factor in the ECB decision making at future meetings.
It still seems likely that the Euroland economy will pick up further, but last week’s survey data, limited though it was, indicated that the improvements from here on in are likely to prove trickier to engineer. Should momentum in the Euroland economy slow, that could provide the worst of all worlds for Euroland, with weakening activity rates but temporarily higher inflation rates. Euroland will also face, or is already facing, the withdrawal of some of the pandemic driven fiscal stimulus. What sort of problems could that create? Will Euroland experience additional divergence in terms of economic activity amongst its member states and could that cause further disunity?
This week, the focus of attention is also on survey data. Already released today (8 Aug), French industrial sentiment dipped in July, from 107 to 105, whilst the Euroland Sentix investor confidence survey for August dropped from 29.8 to 22.2. For the remainder of the week; tomorrow we see the German ZEW survey for August, which is expected to report a further drop in the expectations component but a rise in the current situation index. On Thursday there is Euroland industrial production data for June, which is expected to record a small drop in output on a month-on-month basis after a 1% decline in May, and that’s really it from a data perspective. The final consumer price inflation readings for July that are due shouldn’t offer much, if any new information. The euro will struggle to recoup any of its losses this week on the back of another light data calendar week.
Central banks – Brazil and Czech Republic hike; Banxico to hike this week?
Last week saw a number of key central bank meetings outside of the Bank of England MPC meeting. First up, the Reserve Bank of Australia saw the interest rate decision leave rates on hold, as expected, and stuck with the decision to taper bond purchases to A$4bn per week. The Bank of Thailand were next, and left policy unchanged, but the vote was split 4-2 in favour of leaving rates on hold, with the two members dissenting voting for a 25-basis point rate cut. That could pave the way for a cut in interest rates later this year. The Brazilian Central Bank raised interest rates by 1 percentage point to 5.25%, as expected, and signalled that rates would rise again in September, probably by a further percentage point. The central bank of the Czech Republic raised interest rates to 0.75%, and some board members were keen to raise rates by more than 25 basis points as inflation concerns grew. It is likely the Czech central bank will continue to raise interest rates over the coming meetings. The Reserve Bank of India, the final bank to announce in the last week, left rates on hold as expected.
This week sees three main central bank meetings. The central banks of the Philippines and Peru are not expected to raise interest rates on Thursday and Friday. But, Banxico, sandwiched in the middle of these meetings on Thursday evening, are likely to raise interest rates by a further 25 basis points, with the inflation concerns of the majority of the central bank board overcoming a few dissenters. The peso having weakened slightly since the last meeting, offers another reason for the majority to vote in favour of another hike.