May Review & June Risk Events & Themes

Pound Sterling

You’ve surely had your fill of inflation talk. Perhaps that’s because the Bank of England continually fails to predict (or acknowledge) the reality of consumer prices in the UK, leading to consistently higher-than-expected monthly results against the bank’s predictions.

This happened once again in May, when year-on-year inflation hit 8.7%, exceeding BoE forecasts by half a percentage point. For 8 of the past 12 readings, the BoE has undershot the reality and this month saw their least accurate reading yet.

These persistently high consumer prices have granted the UK the dubious honour of becoming the inflation capital of the developed world.

On the bright side, inflation knocked back to the single digits for the first time since August 2022, thanks mainly to a sharp fall in utilities. This was offset by near-record-high food and beverage prices, while core inflation (which excludes volatile food and energy prices) hit a fresh 31-year high of 6.7%.

At least these numbers acted as a vindication of the government’s decision to raise interest rates another 25 points to hit a 15-year high of 4.75%- the 12th consecutive rate hike.

If you ask UK chancellor Jeremy Hunt, the recession risks posed by these hikes are worth it to bring inflation down, and perhaps hard-pressed shoppers are inclined to agree.

“If we want to have prosperity, grow the economy, reduce the risk of recession, we have to support the Bank of England in the difficult decisions they take,” Hunt told Sky News on Friday May 26. “It’s not a trade-off between tackling inflation and recession, in the end the only path to sustainable growth is to bring down inflation.”

Despite these concerns, there is only one G7 member in an official recession right now and it’s not the UK (spoiler alert: It’s Germany). Furthermore, retail sales were surprisingly on the upside, doubling expectations by coming in 0.8% higher according to the June 26 read.

This, plus Hunt’s comments, combined with prime minister Rishi Sunak’s stated intention to halve inflation by the end of 2023, makes the idea of further hikes a distinct possibility. Bloomberg data shows the market pricing in a rate peak as high as 5.5% by the end of the year.

Given this hawkish outlook, you would expect the pound to rally as international investors sniff out handsome interest rates on the money markets. Indeed, the pound showed aggressive bullishness against the euro in the opening stages of the month.

Softer eurozone core inflation announced on May 2’s flash reading spurred a 2% drop on the EUR/GBP pair that played out over the following week, falling from the May high of 0.8834 to 0.8659 by May 11.

The EUR/GBP pair was extremely choppy for the rest of the month, with price action generally staying between 0.8670 and 0.8710.

A monthly low of 0.8648 was reached after the pound went on a rally following the top-heavy May 24 inflation read.

Across the entire month, EUR/GBP fell from 0.8767 to 0.8684, marking a 0.95% decline on the pair.

Euro

As noted above, the euro was generally weak against the pound throughout May, a reflection of the comparatively weaker inflation read across the eurozone.

That being said, EU inflation actually ticked higher by one basis point per the final readout on May 17, inching up from 6.9% to a flat 7%. Furthermore, Germany became the first and so far only G7 member to officially enter a recession.

But that doesn’t change the fact that the EU’s 7% year-on-year inflation is far better, economically speaking, than the UK’s 8.7%.

Also weighing on the euro is the repricing of China’s growth prospects, which is impacting Europe’s important manufacturing output. As ING said, “the euro tends to do well when China is doing well, given the large share of manufacturing in the Eurozone economy.”

As evidence of the weaker manufacturing sector, the Purchasing Managers’ Index (PMI) fell from 48.5 to 46.3 in May.

Investors should also be keeping an eye on France’s business climate indicator, which fell to 100 for the first time in two years. This indicator is based on monthly business surveys and is designed to deliver an assessment of business sentiment in the country.

Whichever catalyst you choose, EUR/GBP saw a 1.09% downside throughout May, going from 0.8767 and closing at 0.8671.

Unsurprisingly, given the dollar’s strength, EUR/USD closed much weaker, opening at 1.1010 and closing 2.7% lower at 1.0716. The pair’s trajectory was almost uniformly on the downside with only a handful of days closing noticeably higher.

Dollar

The US conversation was dominated by national debt and the impending debt ceiling. As is typical with partisan US politics, both sides were unable to agree on how to tackle the problem in the lead up to the June 5 ‘X-Date’, when the government faced a potential default.

“A failure to do that would be unprecedented,” Fed chair Jerome Powell said in an early May press conference. “We’d be in uncharted territory ... and the consequences to the US economy would be highly uncertain and could be quite averse,” he added.

Those consequences would have included recession, unemployment and a breakdown in essential social services. Thankfully, an agreement was struck in the final days of May, with Congress expected to vote on June 1.

Though a deal was seen as likely, that did not stop the whole circus from having a big impact on the forex markets throughout May, with price action very much on the upside.

On May 15, ING analysts said, “what is really keeping the dollar afloat at this stage is the debt-ceiling impasse in Washington, in our view. Barring positive news on this end, we think the balance of risks remains tilted to the upside for the dollar for now, which should see safe-haven flows as risk sentiment stays subdued.”

Put simply, the greenback’s safe-haven status came into play once again amid turmoil in the debt scene. The dollar truly dominated the forex markets, with the US Dollar Index (DXY), which tracks the greenback against 10 major international currencies, surging from 101.2849 to 103.8579 throughout the month, marking a 2.5% gain.

As for the GBP/USD pair, Cable continued to experience downside well into the third week of the month, even though hot UK inflation data as released on May 24 would typically have the opposite effect. Analysts took this as a sign that the greenback is really driving FX prices at the moment.

GBP/USD hit a May low of 1.2307 on May 25. However, pound strength returned from the 26th, preceding three solid trading days of upward Cable momentum. This was down to a cooling of the US dollar since a debt-ceiling deal looked more likely.

As of May 30, the pound was buying 1.2347 US dollars, marking a 1.7% dip from the start of May.

June Risk Events & Key Themes

USD

Debt ceiling: though a deal has been agreed, it still needs to be voted through Congress, with the vote expected to happen on June 1. Aspects of the deal, which didn’t include any student debt relief or tax hikes (two things sought by the Democrats), will be mulled over in the weeks ahead to assess their impact on the US economy. One of the hottest political topics will be the US$80bn in funds secured to enforce tax rules on wealthy Americans.

Interest rates: Federal Open Market Committee (FOMC) minutes suggest a pretty even split as to whether rates will increase again in June, though the balance still leans more towards a pause. Fed chair Jerome Powell said the bank will make decisions “meeting by meeting”. A slew of inflation and PPI data on June 13 and 14 will offer some stronger insights before the hike-or-pause decision on June 15 (lowering rates is pretty much out of the question).

EUR

Manufacturing output: weaker manufacturing output is starting to weigh on the Eurozone’s economic vitality. Even though Services PMIs are strong, the composite PMI (which tracks services and manufacturing together) fell from 54.1 to 53.3 in May, the first decline since October last year, due to weak manufacturing numbers. This points to a strong divergence between services and manufacturing health across the Eurozone. Keep an eye out for PPI data on June 5.

China rebound: American think tank The Council on Foreign Relations has called the initial expectations of China’s post-Covid economic recovery “exaggerated”. Most other analysts have expressed the same opinion. Sluggish China recovery is likely to heap pressure on Europe’s manufacturing output given China’s importance as an export market. European powerhouse Germany has already seen a bid drop in industrial exports, with fears that a continuation of this theme could spread the recession risk further than Germany. Imports into China unexpectedly fell by 7.9% against a prediction per the May read, making for a high-stakes announcement on June 7.

GBP

Inflation: Britain remains the most inflation-prone member of the G7 set, the effects of which continue to dominate the economic discussion. This makes June 21, when the next inflation read is released, without doubt the most important date in the economic calendar to watch out for. Inflationary effects on borrowing costs will also be in the spotlight, particularly for mortgages.

Food prices: as the driving force behind UK inflation right now, food prices deserve particular attention. Depending on who you ask, Brexit-related trade barriers are the cause of staples such as eggs, cheese and milk soaring as much as 25% in recent months. Whatever the reason, food prices are going to be particularly close watched when the data arrives.

Worker shortages: though the Conservative government is steadfast in its anti-immigration rhetoric, there is a case to be made that low immigration numbers from the EU are actually compounding the inflation problem. Jane Gratton, Head of People Policy at the British Chamber of Commerce, said in April, “the government needs to fix the people problem in the economy if it is to have any hope of boosting growth. That has yet to happen, but it is likely to become a hotter political issue in the near future.

KEY DATES IN APRIL

United Kingdom

• June 1: Nationwide housing prices YoY
• June 5: New car sales; services PMI
• June 6: BRC retail sales monitor YoY
• June 7: Halifax house price YoY; BBA mortgage rate
• June 13: Unemployment rate
• June 14: GDP YoY; balance of trade; construction output YoY; industrial production YoY
• June 21: Inflation rate YoY; PPI output YoY
• June 2: BoE interest rate decision
• June 30: Car production YoY; Nationwide house prices YoY

EUROZONE

• June 1: Unemployment rate (exp 6.5%); inflation rate (exp 6.3%)
• June 5: PPI YoY
• June 8: Employment change YoY; GDP growth rate YoY
• June 14: Industrial production YoY
• June 15: ECB interest rate decision; balance of trade
• June 16: Inflation rate YoY; CPI
• June 19: Construction output YoY
• June 22: Initial jobless claims
• June 29: Consumer inflation expectations
• June 30: Unemployment rate

UNITED STATES

• June 1: Initial jobless claims (exp 245k); manufacturing PMI
• June 2: Non-farm payrolls (exp 195k)
• June 5: Services PMI
• June 7: Balance of trade
• June 12: Consumer inflation expectations
• June 13: Inflation rate YoY; monthly budget statement
• June 14: PPI YoY
• June 15: Federal Reserve interest rate decision; retail sales YoY; initial jobless claims
• June 27: House price index
• June 29: GDP growth rate

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