It has been another week to keep markets on their toes. Of particular interest has been the slide in sterling to a 10-month low against the US dollar (hitting 1.2958). It also slipped against the euro, albeit to a lesser extent.
The depreciation seemed to be a reaction to both weaker than expected UK economic data and further uncertainty around Brexit. A series of data releases provided reasons for doubt whether the Bank of England will raise interest rates on the 2nd August. Nevertheless, interest rate futures markets still attach close to 80% probability to an August hike. We continue to think that BoE policymakers will focus on the bigger picture rather than the most recent data releases, and that an increase is the most likely outcome. Previous experience suggests that the Bank is unlikely to want to surprise markets on the day, but with the pre-announcement blackout period due to start early next week, Bank policymakers only have a few days to impact on market pricing.
Indeed next Monday’s speech from BoE Deputy Governor Broadbent is the last scheduled public appearance by a Monetary Policy Committee member ahead of the August policy decision. Meanwhile, next week’s very light UK data calendar (including CBI industrial and retail sales surveys) is unlikely to have much impact on markets.
Brexit developments also continue to buffet the pound. This week the House of Commons eventually passed Brexit related trade and customs bills but only after considerable manoeuvring and some amendments. Parliament will take its summer break after Tuesday, which may ease some of the pressures on Prime Minister May in the near term, although further votes on Brexit bills will need to take place when parliament returns in the autumn.
In the meantime, Brexit negotiations are likely to continue. Of immediate interest to markets will be the EU’s reaction to the UK government’s latest proposals as embodied in its recent White Paper and in this week’s legislation. The EU has indicated that there will be no immediate official response, but that doesn’t rule out unofficial comments.
Elsewhere in the world, international trade tensions remain very much in focus. The Chinese yuan sold off sharply this week, though it continues to see resistance at higher levels (likely from China’s central bank directly or indirectly lending support). US President Trump tweeted his concerns about the yuan’s level and his preparedness if necessary to further expand tariffs on imports from China. President Trump is also set to meet EU Commission Head Juncker on Wednesday to discuss trade links with Europe. Ongoing trade threats from the US and the possibility of retaliation by other countries remain a source of concern for markets. So far, however, ‘hard’ economic data is showing no significant sign of a negative impact on economic activity.
Recent Chinese data indicates slowing growth momentum into H2, while US economic activity remains buoyant. Next Friday’s initial reading for US GDP growth is expected to provide a further indication of the strength of activity. We expect an annualised quarterly rise of 4.3%, up from 2.0% annualised in Q1, led by strong growth in consumer spending and exports. If realised it would be the fastest quarterly growth rate for four years. While the second quarter GDP outturn probably overstates the underlying pace of activity, it is another indication that economic growth is currently above trend and is likely to remain there (in the absence of a significant negative shock).
Meanwhile this week the Fed’s most recent Beige Book of anecdotal reports from business pointed to signs that the economy may now be starting to overheat. These factors lie behind Fed Chairman Powell’s reiteration in his testimony to Congress that the Fed is likely to continue to raise interest rates.
Economic growth in the Eurozone slowed sharply in Q1. While that was partly a result of temporary factors, the Q2 rebound has seemingly proved to be weaker than expected. We will get some indication of this with France’s Q2 GDP estimate on Friday and from the Eurozone outturn the following week. They are likely to show growth stronger than in Q1 but below the gains of last year.
The July Eurozone PMI and German IFO surveys will provide more timely indications, but are unlikely to point to a marked acceleration in economic activity. These factors point to the need for caution by the European Central Bank in running down its stimulus programme. At its last policy meeting, the ECB indicated that it would end its net bond purchases after December and would probably start raising interest rates at the end of next summer. Since then, at least some ECB policymakers have indicated that growing confidence in inflation’s return to target may justify an earlier hike in rates. However, the relatively downbeat growth outlook points in the opposite direction. This means that ECB President Draghi will face a difficult balancing act when making his post meeting comments. The ECB is very unlikely to change its policy proposals at this stage but Draghi will probably emphasise that they need to proceed cautiously and that their actions will ultimately be driven by how economic growth and inflation evolves.
See you next week!
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