The most recent PMI surveys suggested a slowdown in business activity in May. On the Services reading, this was particularly large, dropping from 58.9 to 51.8. This is expected to be due to the war in Ukraine and China’s lockdowns, as well as the cost-of-living increases. Chancellor Sunak has announced a £15bn package of measures to support households in an effort to shield the economy from the cost-of-living increases. A 25% energy profits levy on oil and gas companies could raise around a third of the total and will include a mechanism to incentivise investment.
Overall, according to the Treasury’s analysis, the measures announced both this week and in February, will benefit households in the lowest income decile by around £1,200. The average household will benefit by about £800.
Ten-year gilt yields have been rising again, possibly in response in part to higher government borrowing. Despite the uncertain economic outlook, financial markets are fully priced for the Bank of England to raise interest rates by 25bp in the June and August meetings, which would bring Bank Rate up to 1.5%.
GBPEUR – 1.1651
GBPUSD – 1.2499
In the Eurozone, the focus will be on the policy update from the European Central Bank on Thursday. The inflation outlook will be provided in new macroeconomic projections. Eurozone inflation has continued to surprise us with the recent May reading at 8.1%. Even core inflation (excluding food and energy) is well above target at 3.8% with strong price rises for services and industrial goods.
A growing concern for rate-setters is that inflation may not return to the 2% target over the medium term without policy action. Therefore the ECB is expected to announce this week that net asset purchases under its QE programme will end in early July. This would pave the way for an interest rate increase at the next meeting on 21 July. ECB President Lagarde played down prospects of a 50bp rise but did indicate that interest rates will likely rise again in September. If we see 25bp rises in both July and September, that would lift deposit rates out of negative territory from -0.5% to 0%.
EURUSD – 1.0727
EURGBP – 0.8583
There are signs from business surveys including the PMI surveys that activity in both manufacturing and services may be cooling. Housing data also showed moderating activity as interest rates rise. The Fed’s preferred inflation gauge, the PCE deflator, has started to fall which may be the start of a gradual descent. The minutes of the Fed’s May policy update, still reaffirmed that US policy rates are likely to rise by 50bp in the next two meetings in June and July, to take Fed Funds to 2%. Further June and July hikes will leave the Fed “well-positioned later this year to assess the effects of policy firming”.
We have seen the labour market report which showed 396,000 jobs added, which was in line with expectations, with unemployment stable at 3.6%. There are some suggestions that wage growth may have peaked, although the labour market remains tight. This week, we will see CPI inflation, where markets expect to see a slight decline in the headline rate to 8.2%, with a decline in core inflation to 7.8%. This would add to hopes that inflation is on the way down, albeit slowly and from elevated levels.
GBPUSD – 1.2499
EURUSD – 1.0727
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*Interbank rates correct at 7 am on the date of publishing.