Currency Update – 1 August 2023

GBP
The Bank of England are fully expected to follow the likes of the Fed and ECB and raise UK interest rates by another 25bps next week, despite the recent positive signs on moderating inflation. Much the same as in Europe (but not the US), economic data has pointed towards weakening activity, which could impact the BoE’s ability to raise rates much further, certainly if the UK falls into a recession. The latest poll from the good people at Reuters, expects the BoE’s terminal rate to peak at 5.75%, which would imply a further three 25bps hikes (including next week). Interestingly enough, a majority of the chancellor’s seven-member economic advisory council are becoming increasingly concerned that the BoE run the risk of raising rates too much over the coming months. They might do well to ignore that Reuters poll.
Whilst the UK may not have the highest debt to GDP ratio among developed nations, the cost of borrowing against government revenues has itself reached an alarming 10%, which is seriously impacting the government’s spending plans, a situation which will only deteriorate should the BoE continue to raise UK rates. Maybe that is part of the reason why the economic advisory council spoke out? In their latest update, the IMF also think that the UK will continue to see tepid growth throughout the rest of the year, with only Germany likely to grow at a slower pace among developed economies.
Among the data, the latest PMI readings (on Monday) dropped to 45 (from 46.5) for manufacturing and 51.5 (from 53.8) for services. That news also confirmed that the UK private sector is now growing at its slowest pace in six months, as orders decelerate amidst higher borrowing costs and persistent inflation.
The pound has had a fairly flat week overall, with some snappy intraday moves. GBP/USD finally found some support after slipping all of the way from 1.3143 to under 1.2800, but any bounces so far has lacked any sustainability. Markets are probably waiting for next week’s BoE meeting, to see if they show any signs of wavering.
EUR
Much the same as in the US, the ECB raised the key European interest rates by another 0.25% yesterday lunchtime, moving their key deposit rate up to 3.75% in the process. That was the ninth consecutive meeting during which the ECB have now raised rates, taking Euro area rates to a 23 year high. In her post-meeting conference, ECB head Christine Lagarde would not be drawn on whether the ECB would likely raise rates again at their next meeting in September, suggesting that ‘we might hike, or we might hold,’ but more on that below.
Clearly the big difference between the ECB and Fed, is that while the ECB may be forced to pause any further rate hikes from here, the change of policy would not be because inflation has reached anywhere near ECB’s target level, but due to accelerating economic weakness among the region. The news this week only added to those worries, as the latest German IFO survey largely disappointed, with both the overall Business Climate and Current Assessment components missing estimates. The head of the IFO also suggested that Germany is still likely to be in a recession, with the IMF later warning that Germany will probably be the only G7 economy to suffer a contraction during 2023. German growth and inflation data are both released a little later today.
The latest PMI readings hardly offered any solace earlier in the week, where the constant theme of weakening economies was reflected throughout Europe. The recent slowdown in manufacturing has now morphed into a broader services slowdown, and suggests that those ongoing ECB rate hikes are materially impacting activity. Among the headlines, Germany’s Manufacturing slipped to 38.8, with the regional figure deteriorating to 42.7. Whilst the majority of services readings remained above the key 50 threshold, ALL major European countries missed against expectations. That news has only helped to increase those worries over an impending recession.
Having rallied all of the way up to a cycle high of 1.1275, EUR/USD has since been on a steady decline over the past 10 days, slipping back under 1.1000 for the first time yesterday since the beginning of July. Markets now have increasing doubts as to the ECB’s ability to raise rates any further, which is feeding into a weaker Euro. GBP/EUR is edging back higher towards 1.1700, suggesting that the pound has taken a slight edge over the single currency of late.
It is a big week for data in Europe next week, with both the latest GDP and Inflation data set for release.