Parky's quick take: 31 July

European Central Bank and Federal Reserve hikes were in line with market consensus; will the Bank of England follow suit?

Last week the Fed (Federal Reserve) and the ECB (European Central Bank) both raised official interest rates by 25 basis points, but both also indicated that the signs of a drop in inflation and weakness in economic activity could mean that further interest rate increases from here are likely to be very limited, or that interest rates are at their peak.

It was clear from the statements that both central banks were leaving the door open to additional tightening, but also that the vast majority of the tightening would now be left to do its work, suggesting that interest rate cuts would be unlikely before 2024, and in the case of the ECB, the second half of the year.

What will the Bank of England do this week?

Its meeting on Thursday is accompanied by a revised set of economic projections for inflation and growth. The chances are that the projection for GDP (Gross Domestic Product) will be revised up, but inflation is likely to be weaker than in the May forecasts. So could that be a signal from the BoE (Bank of England) that it is reaching the end of the road in terms of its tightening as well?

The Bank of England has announced that former Federal Reserve Chair Ben Bernanke will conduct the review into the BoE’s forecasting performance, after criticism that it failed to predict the scale and sustainability of CPI (Consumer Price Index) inflation in 2021 and 2022.

From the US, this week sees the release of non-farm payrolls data for July

The US labour market has been running hot for a while, but the most recent data points to a weakness in some elements of labour demand. There are no signs of any surge in average earnings growth, and that should keep a lid on domestically generated inflation pressures.

However, if the US labour market data is stronger than expected, markets might be tempted to price in one more hike from the Fed. Even without another tightening in interest rates, the relative strength of the US economy is likely to offer the USD some support, in my opinion.

Is there room for more GBP and EUR upside against the USD?

Possibly, but as we’ve seen in the past couple of weeks, a lot of the good news for these currencies is now priced in. The weakness of the USD had been driven by a combination of improvements in the relative economic outlooks for the UK and Euroland, supportive changes to interest rate differentials and some improvements to risk appetite.

I’m not sure that there is more room for a sustained increase in the values of the pound or euro against the US dollar, and there is also the prospect that if there is an increase in EUR or GBP values, the recent increases to over $1.11 and $1.30 are still likely to provide resistance.

After Chile cuts by more, will there be more action this week

Last week saw the central bank of Chile cut interest rates by a full percentage point, more than was priced in by the markets. There have been other central banks that have begun to ease monetary policy having hiked aggressively over the course of late 2021 and throughout 2022. The decision to hike interest rates was based around the surge in inflation, and the decision to cut interest rates has happened as domestic inflation pressures appear to ease, along with falls in the global prices (as demonstrated in commodities, particularly energy prices).  

This week sees the RBA (Reserve Bank of Australia) kick things off, and it is expected to hike interest rates again, by 25 basis points on Tuesday morning. The BoT (Bank of Thailand) is also expected to hike when it meets the day after the RBA.

The Brazilian central bank is then expected to cut interest rates by 25 basis points, which is likely to end the central bank action for the week, as the Czech central bank isn’t expected to move interest rates in either direction. Although the markets seem pretty convinced that the RBA and BoT will hike interest rates, I think one or both might spring a surprise, given the weakness in economic activity.