5 June 2023: Economy grew in the first quarter, but fragility highlighted by a weak March

5 June 2023: Economy grew in the first quarter, but fragility highlighted by a weak March


  • Property market back in turmoil
  • U.S. economy creates 339 new jobs in May, smashes forecasts
  • Eurozone’s inflation tumbles driving calls for a pause in rate hikes
GBP – Market Commentary

Bank of England faces a continuing dilemma over rates

The UK economy as expected avoided a contraction in the first quarter despite an unexpectedly large fall in growth in March. The economy shrunk by 0.3% in March which highlighted its fragility.

With the Bank of England under pressure to continue to hike short-term interest rates, it has little “wiggle room” to play with which could see monetary policy take the economy into a recession.

Although there was a collective “sigh of relief” from the market, the Government, and the Central Bank when the IMF concluded that the country is unlikely to suffer a recession this year, there is a growing concern that the economy may struggle to avoid a contraction in 2025.

Rishi Sunak and his Cabinet are clearly relying on an improving economic performance to provide them with a slim chance of remaining in Government following the General Election which must take place before January 2025, but is slated to happen in the Autumn of next year.

The BBC interviewed Larry Summers, the eminent economist, and Treasury Secretary during the Presidency of Bill Clinton last week and painted a particularly dark picture of the country’s prospects. He believes that it is “highly unlikely” that there will be no recession during the life of this Parliament, also commenting that Brexit is the single factor that marks the UK from its G7 partners when it comes to inflation, which will in time be seen as a “historic error”.

The UK is still the only country in the G20 whose economy remains smaller than it was pre-Pandemic. It is still 0.5% smaller than it was in 2019.

The relief that was seen by the markets over housing data turned out to be short-lived. Nationwide, the country’s biggest mortgage lender published a report that showed that house prices fell by their largest amount in fourteen years.

Rising interest rates and the return of the withdrawal of several mortgage products have led prospective buyers to again become cautious about moving house.

The country suffered the return of rail strikes last week as a stalemate between unions representing railway workers and the Government reached a stalemate. While the Unions are demanding a wage increase at the level of inflation, the Government believes that the offer that they have made, that has been independently verified, is affordable and fair.

It is estimated that the strikes so far have cost the economy five billion pounds.

Last week, Sterling snapped a three-week losing streak as the markets expected the Bank of England to continue to hike rates at the next meeting of the MPC.

It rose to a high of 1.2544 but ran out of steam and closed at 1.2444.

This week, output data for May will be released and this is expected to remain well into expansive territory. Potentially critical further housing data will be published by the Halifax Building Society, while two independent members of the MPC will be making speeches.

USD – Market Commentary

Employment data was a major shock to the FOMC

The CEO of Wall Street Investment Bank J.P. Morgan spoke in the wake of the release of the May Employment Report and suggested that the Fed will raise interest rates in the U.S. to at least 5.5% before it is able to consider a pause.

This was mainly because the employment market remains “red-hot,” having produced a staggering 339k new jobs in May, while the April figure was significantly upwardly revised.

Despite the FOMC claiming to be data-driven, there is still a significant expectation that there will be a pause in the cycle of rate hikes that began more than a year ago when the rate-setting committee meets in the middle of next week.

By then the May inflation report will have been published, and it will be truly visible if the members who spoke last week of their “feelings” that a pause may be needed will be truly evaluated.

There is little doubt that the Chairman of the Fed, Jerome Powell, remains as hawkish about inflation as he has been for several months, despite a slight “wobble recently.”

The Fed will have been encouraged by the dying down of the clamour about a coming recession that had become almost deafening. It may be considered now that Powell would favour, or at least accept a “technical recession” if it were a prelude to inflation falling closer to the Central Bank’s target of 2%.

The global economy will have to accept that it is the end of an era in which inflation remains close to zero and borrowing costs are controlled.

The Bill to increase the debt ceiling was passed by Congress late last week, with just enough drama to persuade the market that it was not a complete red herring.

The Federal Government won’t now run out of money and be forced to default on its debt to bring catastrophic fallout to the global economy, which, in truth, is what we all imagined would happen.

The dollar index retreated a little over the week despite the strong employment report. It fell to a low of 103.38 but recovered to close at 104.03.

This week, data for services output will be released, as well as trade data and weekly jobless claims, which have taken on a new significance despite bearing little relation to the employment data.

EUR – Market Commentary

De Guindos says “we are on the final lap of a marathon”

Despite headline inflation falling to 6.1% last month, the President of the ECB, Christine Lagarde remains as hawkish as ever about the continuation of the cycle of interest rate hikes.

While accepting that inflation is now moving in the right direction, Lagarde believes that rates still need to continue to rise since inflation is likely to remain too high for too long.

It is odd given her comments that she is accepting of the Governing Council being prepared to vote in favour of twenty-five, rather than fifty basis point hikes, which would in all probability lower demand and therefore inflation that much more quickly.

ECB Vice Presidents, Luis de Guindos the Head of the Bank of Spain, and Ignazio Visco the Head of the Bank of Italy, both spoke last week of their expectation that the “cycle of hikes” is ending.

De Guindos who has been forthright in his comments recently, believes that the “end of the road” for rate hikes is close, while Visco believes that the fall in the cost of energy will be critical to ending hikes.

Visco went on to say that he expects core inflation to be affected by the fall in energy prices, since it will cool wage demands that have been causing concern in his country.

ECB Chief Economist Philip Lane spoke on a similar theme last week, when he said that he sees the threat of higher wages diminishing over time.

Outside the tightening of monetary policy, the difficulty of dealing with twenty separate economies is constantly being highlighted by the often wildly differing data that is being produced for economic output, the industrial and services sectors and consumer confidence.

The data for the entire eurozone seems to vary extraordinarily little, but contained within it are some major variances.

There needs to be a major review of how the data is produced to make the overall numbers more reflective of the entire picture. While monetary union is a particularly useful tool its effectiveness is significantly diminished without fiscal and banking union.

Last week, the Euro continued its retreat away from the 1.10 level. It fell for the fourth week in succession, reaching a low of 1.0635 and closing at 1.0707.

This week will see the final cut of Q1 GDP released. It is likely to show that the Eurozone grew by 1.2% YoY, down from 1.3% previously, while QoQ the economy was flat.

Have a great day!

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Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.