Dollar Revival
US DOLLAR POSTS LARGEST MONTHLY RISE SINCE 2016
The half-year ended with the biggest monthly rise in the trade-weighted US dollar since late 2016. Both the pound and the euro were down about 3% against the greenback in June. The dollar move has been attributed, for the most part, to perceptions that the US Federal Reserve’s policy guidance at its June meeting was slightly more hawkish than expected, with monetary and fiscal policy measures fuelling a strong economic upturn. There was significant market volatility, however, on concerns that the increase in inflationary pressures may turn out to be less transitory than anticipated, which would probably necessitate a larger policy response. Still, although a growing minority of US rate-setters anticipate an increase in interest rates next year, most expect the first hike only in 2023. In the UK, financial markets are pricing in a rise in Bank Rate of 15bps to 0.25% by August 2022. The most recent policy update from the Bank of England (BoE) says it now expects inflation to “exceed 3% for a temporary period”. Former chief economist Andy Haldane (who has just left the Bank) favoured a reduction in the target for asset purchases and said inflation could be close to 4% by the end of the year. However, reflecting the majority view on the Monetary Policy Committee, Governor Andrew Bailey pushed back and remarked that, “It is important not to overreact to temporarily strong growth and inflation, to ensure that the recovery is not undermined by a premature tightening in monetary conditions”.
HOW PROTRACTED MIGHT SUPPLY CONSTRAINTS BE?
The BoE’s central view is underpinned by the judgment that there remains spare capacity in the economy, although that may seem at odds with anecdotal reports of recruitment difficulties in some sectors, including hospitality. It remains to be seen how long-lasting reports of staff shortages turn out to be, in other words, how quickly supply responds to rising demand for staff, especially as the furlough scheme starts to wind down. There are suggestions also that fewer foreign workers may be restricting supply. The latest Lloyds Business Barometer survey revealed that nearly a fifth of companies are experiencing significant difficulties in finding or are unable to find staff with appropriate skills and experience. However, despite rising in recent months, firms’ wage expectations in the survey remain below pre-pandemic rates, an indication perhaps that businesses expect some of the more acute staffing issues to fade over time.
UK GDP TO REAFFIRM STRONG DEMAND
The demand side of the economy remains robust, with economic indicators pointing to the likelihood of a very strong rebound in Q2 GDP growth as Covid restrictions are eased. The BoE has already revised up its Q2 forecast to about 5½% from 4¼%. Official figures for April showed a particularly strong monthly rise in services output of 3.4%, offsetting surprising declines in manufacturing and construction, resulting in an overall 2.3% increase in GDP. We expect May GDP (Fri) to post an additional gain of 2.5%, reflecting a further expansion in services as well as rebounds in manufacturing and construction. Overall, it is possible that Q2 growth may be even stronger than the BoE’s latest upgrade, but rate-setters will remain focused on medium-term prospects and, in particular, how supply adjusts. UK trade data (Fri) for May will be released alongside monthly GDP, and are likely to draw some attention given interruptions related to the pandemic and new EU trading arrangements. The latest figures suggest that total export volumes have recovered, although imports from the EU remain lower than in recent years. Also out in the UK are the construction PMI (Tue) and the final reading of services PMI (Mon), which are expected to reaffirm strong activity in those sectors. The RICS housing survey (Thu) is also due, with the last survey showing the strongest house price balance since the late 1980s. Finally, the Office for Budget Responsibility (OBR) is expected to release its Fiscal risks report (Tue), which will be an important update, especially in light of the impact of Covid-19 on the public finances.
WILL FED MINUTES VALIDATE THE HAWKISH VIEW?
Back in the US, the holiday-shortened week is likely to see more attention than usual on the minutes of the June Fed policy meeting (Wed), the outcome of which was perceived to be more hawkish than expected. Markets will be looking for more colour on discussions in particular surrounding inflation risks. While the central view remains that rising inflation is likely to be transitory, policymakers have also acknowledged upside risks. There will also be attention on the start of discussions about the tapering of asset purchases, which will probably occur around the turn of the year. On the data front, the main release will be June ISM services (Tue), which we forecast to remain very strong at 63.7, despite a slight fall from May. Elsewhere, the European Central Bank (ECB) will publish the minutes of its June policy meeting (Thu), when it decided to maintain the faster pace of asset purchases under its Pandemic Emergency Purchase Programme (PEPP). ECB President Lagarde said recently that the Eurozone economic recovery remains fragile. The economy is expected to bounce back in Q2, but less strongly than the US and the UK. There are concerns about the impact of new Covid variants, particularly on services activity, although the latest June PMIs continued to improve. The coming week’s main data releases include German factory orders (Tue) and industrial production (Wed), as well as the ZEW economic confidence survey (Tue). Meanwhile, in the Asia-Pacific, the Reserve Bank of Australia (Tue) is expected to leave interest rates unchanged, but may tweak its QE policy, while there will also be attention on Chinese inflation data (Fri).
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