Last week, we saw UK inflation rise more than expected, with an increase of 2.5%, above market expectations for 2.2%. The markets are now concerned about an earlier withdrawal of monetary policy stimulus. Much of the recent rise in inflation is due to factors resulting from the pandemic. These include higher energy prices, supply constraints relating to global trade disruptions and reopening of domestic economies, all of which are pushing up costs. To the extent that these factors are transitory, inflation should eventually fall back.
The Bank of England MPC members appear to be concerned about these inflation surprises. Deputy Governor Dave Ramsden said that UK inflation could reach 4% this year. He also noted that conditions for policy tightening could be met sooner than previously expected. External MPC member Michael Saunders added that, “it may be appropriate fairly soon to withdraw some of the current monetary policy stimulus”. The MPC meeting on 5 August will have new economic forecasts and may have a reassessment from policymakers on the outlook and risks for inflation.
This week, we see Freedom Day as cases continue to rise, caution is urged. As the recovery continues, the rate of expansion should start to ease. We expect services and manufacturing PMI to both edge lower to around 62. This still represents strong growth for both sectors. Consumer confidence is likely to have improved further, with retail sale potentially falling slightly in June after a strong quarter.
GBPEUR – 1.1653
GBPUSD – 1.3753
The main focus this week is the European Central Bank policy update. This meeting will implement the conclusions of the strategy review. The review changes the price stability goal to a symmetric medium-term 2% inflation target. This is seen as more dovish that the previous target of ‘below, but close to, 2%’. The new policy also states that, at the lower bound for interest rates, ‘forceful or persistent’ policy is required which ‘may also imply a transitory period in which inflation is allowed to be moderately above target’.
While interest rates are likely to be unchanged, President Lagarde has indicated that the forward guidance will be realigned with the new inflation remit. Guidance on interest rates is, therefore, likely to be more dovish, possibly with a reference to allowing inflation to overshoot 2% temporarily. There will also be interest in potential indications on whether the ‘higher pace’ of purchases under the Pandemic Emergency Purchase Programme will extend beyond the current quarter. For the Eurozone flash PMIs, we expect a further improvement in services to 59.5 and manufacturing to 63.5. Both measures suggest that the recovery continues in the third quarter.
EURUSD – 1.1802
EURGBP – 0.8581
In the US, inflation was also higher than expected, rising to 5.4% in June, which is the highest since 2008. This surprised markets expecting a small decline. These increases are partly a result of higher energy prices and supply constraints relating to global trade disruptions and reopening of domestic economies. The Federal Reserve still seem confident that inflation will fall back. While acknowledging upside inflation risks, Fed Chair Powell noted last week that the labour market has continued to improve, but with a long way to go.
This week there is very little data. There are no Fed speakers ahead of the the FOMC meeting on 27/28 July. Housing data, including starts and building permits may show that activity is steadying. The Markit flash PMIs will provide an early look at July activity. Both manufacturing and services PMIs are expected to remain in strong growth territory. Last week, retail sales rose unexpectedly by 0.6% for June.
GBPUSD – 1.3753
EURUSD – 1.1802
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*Interbank rates correct at 7 am on the date of publishing.
