News & Analysis


UK inflation data published at 7:00 BST this morning revealed a significant upside beat against expectations across all inflation measures. Headline inflation, whilst falling from last month’s 10.1% YoY to 8.7% in April, still substantially outperformed pre-release expectations for this to fall to 8.2% YoY. More concerning for the BoE will be core inflation, which increases from 6.2% to 6.8% YoY, suggesting that underlying inflationary pressures continue to build. This message was reinforced by the trend in services CPI, which has been highlighted by the BoE as an indicator for underlying inflationary pressures, also showing an uptick and increasing from 6.6% to 6.9% in April. With data coming in above both expectations and BoE forecasts across the board this is likely to place significant pressure on the Bank of England to raise policy rates further at upcoming meetings. Market reaction to this latest release now sees a hike in June as a certainty and almost 100bp of further hiking this year in total. Whilst we are inclined to agree that barring a significant downside surprise in the next round of data releases, a hike in June is now the base case, 100bp of additional monetary tightening seems excessive. Signs of slowing inflationary pressures remain, with the labour market beginning to weaken and mechanistic falls in energy and food prices still to flow through to consumer prices, in our view today’s data strength represents weakness that has been postponed for coming months but with risks to this forecast skewed once again to the upside. For sterling, the significant uprating in monetary policy expectations puts concerns around financial stability and growth back in the cross hairs. This can bee seen in FX markets this morning, with cable only hovering around pre-release levels as traders increasingly have to weigh the benefits from additional tightening on carry against other downside risks coming into view.


Against a backdrop of broad USD strength, the single currency fell back to its March 27th lows, but failed to break the support level for a third time in four trading days. The euro weakness was notable as early in the morning May’s preliminary PMIs showed the ECB is yet to see the back of its services inflation problem, despite a broad cooling in activity levels.  This resulted in more hawkish expectations being priced into the EUR OIS curve, with the probability of three more rate hikes rising 20 percentage points to 40%. Nonetheless, this provided very little support for the single currency, with interest rate differentials playing a support role to debt ceiling dynamics. In that light, comments by ECB President Christine Lagarde at 18:45 BST may have little impact on the euro.


Although the dollar did exhibit a period of weakness yesterday afternoon as manufacturing indices pointed wholeheartedly to the sector being in recession, this slump was short-lived as markets continued to trade debt ceiling developments and the Fed’s hiking path as their primary concern. On that note, it was more of the same yesterday, with positive tones emanating from Washington but a tangible deal still elusive. Nonetheless, the positive mood music still led to less rate cuts being priced in this year, with just under 40bps now factored in by money markets. This dynamic was compounded by the S&P services PMI for May, which unlike the manufacturing index showed considerable strength as it rose to a 13-month high of 55.1, beating expectations by 2.6 points.

The tables might be starting to turn within the cross-asset space this morning, however, as Fed speakers Bostic and Goolsbee indicated their preference for a pause at the next meeting and talks in Washington look to have broken down again with no further meetings planned, according to top aide Garret Graves. This has led 2-year Treasury yields to trade considerably lower this morning, retracing back into its previous range. Meanwhile, in FX markets, the dollar is trading softer across most of the currency board, with only a few exceptions. Should Congressional leaders fail to boost the mood once the US session begins, markets are likely to become increasingly jittery. Equity analysts from most major primary dealers have repeatedly stated that their asset class is likely to throw a tantrum should a deal remain absent by the end of the week. We agree and think the pain is likely to be felt across all asset classes. For reference, the absence of a deal into the X-date back in 2011 led the dollar falling around 1.85%. Watch this space.

Outside of debt ceiling discussions, the market focus will be firmly on US monetary policy with Fed Governor Waller expected to be the latest voting member to chime in on the debate over whether to hike or hold at the June meeting, while the Fed’s May meeting minutes are released this evening.


There wasn’t much to report on for the Canadian dollar yesterday, with much of the intraday volatility being driven by US debt ceiling news. This led the loonie to briefly weaken to levels last seen last Monday before reversing back to flat against the greenback. By the end of the trading session, the Canadian dollar was at the top of the G10 currency board in a 3-way tie with the US dollar and the Japanese yen, and in line with our end-of-month forecast for May. While FX markets hardly reacted, StatsCan published its latest raw materials and industrial product price indices, which tend to lead consumer inflation, albeit with a highly imperfect relationship. Raw materials rose by 2.9% in April, rebounding from March and blowing past expectations, while industrial prices edged down -0.2% and fell short of the 0.1% gain that was anticipated. In the meantime, Canadian newspapers focused on politics, with special rapporteur David Johnston delivering his first report on Chinese interference. Johnston announced that he would not be conducting a public inquiry, citing national security risks, a decision that was criticised by the Conservatives, New Democrats, and Bloc Quebecois. While not an immediate driver for the Canadian dollar, these political developments do pose a tail risk that an election is called should the House of Commons table a no confidence vote, and could eventually impact the currency if the risk becomes more prominent.

FX Elsewhere

The kiwi dollar is the big mover overnight, trading 1.7% lower into the European open this morning after the Reserve Bank of New Zealand cast a resoundingly more dovish tone than markets had expected by hiking the overnight cash rate by 25bps to 5.5% and delivering much more neutral guidance. While consensus expectations coming into today’s RBNZ meeting was for a 25bp hike, most analysts had predicted a higher terminal level for the OCR at around 5.75-6%. For some, this would have been achieved at least in part by a 50bp hike today, while for most this was expected under successive 25bp hikes. Meanwhile, markets had priced in a 38bp increase prior to the meeting, with a terminal level just shy of 6%. Given these expectations, the decision to hike just 25bps naturally weighed on the kiwi dollar at the margin, but more importantly for markets was the guidance. Firstly, the MPC voted 5-2 in favour of the hike, with the two dissenting members opting for a pause. Furthermore, the revisions to the RBNZ’s macro forecasts were resoundingly dovish, with the OCR projections little changed with a terminal rate of 5.5% for 24H2, considerably below market expectations. On the whole, the message from the RBNZ was that this was likely their last rate hike of this cycle, barring any significant resurgence in inflation pressures from the consumer or labour market.



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