Sterling advances as UK election called for July

Highlights:

GBP rises to March highs as UK election unexpectedly called for 4th July.

ECB policymakers hint at June interest rate cut. Euro Area PMIs disappoint expectations.

Japanese authorities ramp up yen intervention talk, as USD/JPY rate approaches line in the sand.

Hawkish RBA, RBNZ policy announcements suggest no cuts for some time.

Last week was light in news and policy developments, and currency markets, like bond markets and risk assets in general, traded in fairly tight ranges.

The trading themes of the last few months still rule. Markets are pushing back the timetable for interest rate cuts, particularly in the US. Economies worldwide are posting generally positive numbers, but inflation figures remain stubbornly above central bank targets, which is increasingly limiting the timetable and scope for interest rate cuts. The European Central Bank now seems the exception to the rule, with recent communications seemingly confirming that the Governing Council will cut interest rates at its meeting next Thursday.

This week’s data releases, and monetary policy news will be heavier than the previous one. One data point whose importance may be underestimated by markets is the flash inflation report for May out of the Eurozone on Friday. Inflation prints have generally come out higher than expected in the main economies, in a sign that the inflation rebound in the US is actually a worldwide trend rather than a domestic one. Any upward surprise could translate into delay of expectations for ECB cuts beyond the June meeting, which could potentially boost the euro.

USD

Rates across the curve in the US continue to drift upwards, slowly but relentlessly. In the absence of key data, last week it was hawkish Federal Reserve communications that fuelled the rise. It is hard to believe now, but at the beginning of the year markets were fully pricing over six 25 basis point cuts in 2024, and the latest read is barely more than one, with less than a 50/50 chance of a September cut.

It is all about inflation, and the focus of the week will be the Personal Consumption Expenditures (PCE) inflation index for May, out on Friday. This is an alternative index to the earlier CPI report, but it’s generally preferred by Fed officials. Economists are optimistically expecting a lower monthly read in this report than the CPI, and any disappointment may lead markets to consider further the prospects for any cuts in 2024.

EUR

The May PMIs of business activity came out a touch weaker than expected, but remain consistent with solid though unspectacular economic growth, with a strong services sector making up for weakness in industrial activity. ECB communications confirmed that a cut in June is certain, but as elsewhere markets continue to push back the timetable for future cuts. Rate trades no longer expect a full second rate cut until October, and fewer than two cuts are priced in for the whole of 2024 right now.

We are focusing on the key flash inflation report for May, due at the end of the week. Should we see the kind of upside surprises we are getting elsewhere, we would expect the common currency to push back towards the end of its recent range.

GBP

The UK inflation data for April was the latest to show that the disinflation trend of 2023 has stalled in most places. The key core data fell below 4% on base effects, but the number was much higher than markets had been expecting. Services inflation remains stubbornly high, near 6%, and rate traders no longer expect a rate cut before September, at the least, the same trend towards fewer cuts later that we are seeing in most advanced economies.

The surprise announcement of elections for 4th July had essentially no effect on markets, as these have already got comfortable with the prospect of an overwhelming Labour victory. Higher rates for longer and the generally positive tone in UK economic data continue to fuel a rally in sterling.