Sterling Hits Fresh Lows
In the UK, as the Tory leadership race contenders start to declare candidacies Sterling has touched fresh lows this week. And as the race develops, if - as our analysts expect - they battle intensifies about who amongst them will offer the most extreme of Brexits, there is scope for Sterling to go lower this Summer. It's likely to be a very crowded field, with 12 Tory MPs having indicated that they will stand, so far, and others may declare before the end of next week.
Parliament will return from recess on Tuesday and the focus will inevitably be on the Conservative leadership election set to officially kick off the following week. S In the near term, attention may be drawn away from the contest by President Trump’s visit to the UK. Nevertheless, with MPs back at Westminster it may become more apparent as to which candidates are drawing the most support.
The coming week’s UK data calendar is again fairly light with no official releases of note. However, the May PMIs will provide some further timely updates on UK growth. The manufacturing PMI slipped In April, following a particularly strong reading for March that seemed to have been primarily driven by pre-Brexit stock building, but it stayed well above the 50 expansion/contraction level. In contrast both the construction and services indicators rose back above 50 in April. We expected another modest decline in manufacturing for May, but increases in both construction and services. Overall the surveys are pointing to weaker economic growth in Q2 compared to Q1’s 0.5% rise. This is likely to pile even more pressure on the Pound.
We do not expect the ECB’s Governing Council to make any changes to its policy guidance at next week’s meeting. ECB President Draghi is likely to confirm that the ECB’s baseline forecast is still a recovery from the current ‘soft patch’. He will, however, likely emphasise that the risks to this remain tilted to the downside. For now, it will stick with guidance that only rules out an interest rate hike before the end of this year.
It has been another difficult week for global equities with sharp falls across most markets. Ongoing concerns about trade tensions between the US and China have escalated into more general doubts about risks global economic growth. The announcement late on Thursday by US President Trump that he now plans to raise tariffs on goods from Mexico unless the Mexican government curbs illegal immigration into the US has added to the negative mood in markets. With investors looking for safe havens, government bond yields, led by US Treasuries, have fallen sharply. The particularly rapid decline in 10-year Treasury yields has taken them below 3-month yields, a move that is seen as signalling a greater risk of a recession (see Chart 1). The moves over the past couple of weeks have taken place despite a general absence of much new economic data. In contrast, the week ahead has a much busier calendar particularly in the US. That will culminate with Friday’s labour market report for May. We expect that to suggest that the economic conditions remain sound for now with a 195k monthly rise in employment, alongside the unemployment rate holding at a 49-year low of 3.6% and further moderate wage gains. Ahead of that, the May ISM manufacturing (Mon) and non-manufacturing (Wed) surveys, along with official reports on April construction spending (Mon), factory orders (Tue) and international trade (Thu) will provide insights into key parts of the economy. We expect a series of generally relatively solid reports, but it remains to be seen whether they will do anything to help calm market fears. Meanwhile, the next Fed policy meeting (18-19th June) is shaping up as a key date for markets that are convinced US interest rates will be cut before year end. In early May, Fed Chair Powell acknowledged that he and his colleagues would continue to be ‘patient’ before taking any further policy action but played down the possibility of a near-term rate reduction. That briefly led to a fall in the probability markets placed on a 2019 cut, but it has subsequently rebounded and now stands at more than 90%. So far, Fed policymakers have been reluctant to lend support to the market view. For example, in comments this week Fed Vice Chair Clarida, who is considered to be one of the most dovish of the Fed’s policymakers, acknowledged that they would cut rates if necessary but still judged economic conditions as positive. Nevertheless markets will continue to look for any signs from Fed speakers in the coming week that its policy guidance will change in a more dovish direction. The Fed holds a conference this week to discuss its policy framework, but that is likely to concentrate on more medium-term issues.
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