Rising Interest Rates: The Theme Continues

FED UPS THE ANTE ON RATES AGAIN This week has been dominated by central bank updates. Firs t up was the US Federal Reserve, which raised interest rates by 75 basis points, its largest move at a single meeting since 1994. The Fed had originally signalled an intention to hike by 50bp but seems to have been swayed by the May CPI inflation figures proving to be stronger than expected. Next up was the Swiss National Bank, which hiked by 50bp, an even bigger surprise as it was expected to leave interest rates unchanged. In contrast, the Bank of England hiked by a more modest 25bp, while on Friday the Bank of Japan left its policy settings unchanged. The moves by the Fed and the SNB continued the recent trend of central banks making more aggressive than expected hikes in interest rates. Both cited growing concerns about upside inflation risks, that are seen as much more important considerations than other factors such as downside growth risks. The BoJ might be seen as a special case as inflation in Japan has been far below target for a long period of time and even now has picked up by far less than elsewhere. That leaves the Bank of England as arguably an outlier compared to most central banks. Although it has now hiked rates five times in a row and started earlier. Its policy rhetoric with the emphasis on the final balance between growth and inflation risks sounds more cautious particularly when compared to the Fed. So, a big question ahead of the BoE’s next policy update in early August is whether its more ‘gradualist’ message will change any time soon? It has been another volatile week in markets with both bonds and equities fluctuating sharply, firstlyahead of, and then in reaction to, the central bank moves. Government bond yields in the US, UK and the Eurozone all at some point hit new highs for the year, while spreads between Eurozone countries widened sharply. Equity prices have been under pressure for much of the week, although are having a better day on Friday. In currency markets, sterling has been particularly volatile first falling sharply but then rebounding toward the end of the week.

FED CHAIRMAN TESTIFIES TO CONGRESS

There is now a break of a few weeks before the next set of central bank policy updates. In the meantime, markets will be looking for further clues on what to expect from them for the rest of the summer and beyond and there are plenty of central bank speakers next week. In the US, potentially of most significance will be Fed Chair Powell’s semi-annual testimonies to Congress (Wed & Thu). Powell seems set to be questioned closely about how quickly inflation will come down, what level of interest rates will be required and what will be the impact on the economy? He is likely to reiterate the Fed’s commitment to lowering inflation but may find it very hard to satisfy all sides. In Europe, ECB President Lagarde will testify to the European parliament. She seems set to confirm that the ECB will start raising interest rates in July but will probably be asked to provide more detail on the new anti-fragmentation tool for coping with yield spread widening. This, according to reports, will be ready for the July update. Finally, BoE policymakers’ comments will be watched for more on their future intentions beyond this week’s assurance that will they take the “actions necessary” and these may be “forceful”.

NEAR TERM UK INFLATION TO REMAIN ELEVATED UK CPI data for May will provide further evidence on the extent of near-term inflationary pressures. We expect annual headline inflation to remain at 9% reflecting a further pickup in petrol and food prices offset by some easing in ‘core’ inflation. The detail of the change in ‘core’ prices will probably be of particular interest to the BoE as it looks for signs of whether inflationary pressures are broadening out or not. There may be signs of this in another rise in services price inflation, but we expect it to be offset by a deceleration in goods price inflation. Another key UK release in the coming week will be the June PMI data (Thu), which we expect to provide more evidence that activity has softened in the face of headwinds such as higher inflation and interest rates and the war in the Ukraine. Interpreting this month’s data will be complicated by the extra Bank Holiday, which unlike regular holidays will not be covered by the seasonal adjustment process. That may have a variable impact, possibly lowering the level of monthly activity in manufacturing but raising it in some recreational services. Overall, we look for the headline manufacturing index to drop to 54.2 from 54.6 and the services index to fall to 53.0 from 53.4. We also have the June GfK consumer measure in the UK, which will be released on Friday. That has fallen sharply in recent months, probably due to the rise in inflation and potential impact of that on real spending power. We forecast a modest rebound for this month reflecting a Jubilee feel-good factor and possibly also a boost from the announcement of the latest fiscal support package. However, the reading is still expected to be close to last month’s all-time low. In the Eurozone, we expect the manufacturing PMI to fall for a sixth month in June to 54.2. Its output component is now only slightly above 50, weighed down by supply chain disruptions, while total orders last month fell below 50 for the first time in two years. For services, we expect a slight decline leaving it still firmly in growth territory. Pent-up consumer demand and a shift in spending towards services are being offset by rising costs and uncertainty. The German IFO survey has so far shown a degree of resilience in the economy in the face of supply bottlenecks, rising costs and the war in Ukraine. Confidence, however, remains below levels at the start of the year and is consistent with economic slowdown but not (yet) recession. Finally, the US PMI data tend to be watched less closely than their European equivalents but will provide some insight into activity trends.

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