Parky's quick take: 18 July 2023

GBP / USD holds above 1.30 ahead of key inflation report

Sterling picked up more ground last week, benefiting from a broadly weaker USD. Last week’s UK data once again had a stagflation feel, as they showed weakening demand for labour but with still high wage growth and flatlining Gross Domestic Product (GDP) growth. Higher-than-expected wage inflation will maintain pressure on the Bank of England (BoE) to continue tightening monetary policy.

Eyes are on the UK inflation report this week. Near-term interest rates have been one of the major drivers of recent Sterling movements, and an upside surprise in inflation data will likely lend further short-term support to Sterling, in my view.

However, growth risks coming from aggressive BoE tightening will likely play a more important role in the medium term, and Sterling strength from higher interest rates shouldn’t be a foregone conclusion, in my view.

USD suffers big weekly loss post the Consumer Price Index report, eyes on retail sales

The USD started the week on a cautious note after a big sell-off last week, driven by softer than expected US Consumer Price Index (CPI) and Producer Price Index (PPI) reports. The data brought a welcome signal for US inflation and helped lay the path to the end of the Fed’s hiking cycle. While market investors are still discounting a hike at the Federal Reserve’s meeting in July, interest rate expectations thereafter have been tempered, causing a fast rally in US government bonds that pressured the dollar lower on relative interest rates. In the meantime, the counterplay between activity and inflation data remains significant – resilience in US activity data but slowing inflation is a soft-landing combination, which played positive for broader risk sentiment and weighed on dollar’s safe haven demand.

Eyes are on the US retail sales data for June, which will likely be positive, but the underlying trend in spending is slowing. Meanwhile, manufacturing sector data should confirm ongoing contraction in factory activity and housing sector data on starts, permits and sales may have softened in June after recent resilience despite higher borrowing costs, in my view. 

EUR extends gains ahead of European Central Bank speakers

EUR/USD took a one-way track higher last week, although the largest moves came after the US CPI and PPI data was released on Wednesday and Thursday, respectively. The EUR was a beneficiary of unwound dollar selling positions, as US interest rate expectations turned lower and market sentiment turned to positive. The EUR extended gains this morning, although softer activity data of late in the Euro area risks an earlier dovish pivot by the European Central Bank (ECB), despite the current hawkish rhetoric.

Several ECB policy makers including President Lagarde are due to speak this week, and will likely provide further insights on the central bank’s policy stance. This week will also see some final June inflation data released in the region, but it might not have a significant impact on the EUR given possibilities of little changes from previous releases, in my view. 

Central Banks: further hikes likely from South Africa and Turkey central banks

This week is relatively quiet on central banks front, with only South Africa (SARB) and Turkey (CBRT) central banks meeting on Thursday. Slowing domestic inflation, a prospective end to the US’s tightening and thus reduced pressure on the rand means South Africa’s central bank could justify halting its 475 basis-point, 19-month long hiking cycle. But a final 25 basis-point hike from the SARB still seems likely, given May inflation data came in well above midpoint target and inflation expectations continued to rise.

For CBRT, a bigger percentage of economists are expecting a 300 basis-point hike up to a policy rate of 18.00%, according to a Bloomberg survey.