GBP/EUR reaches its highest level this year – Sterling Update

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GBP

The latest UK inflation report was somewhat mixed for April. As expected, the headline CPI thankfully fell from double digits to 8.7% per year. However, markets expected a bigger drop to around 8.2%. More worrisome for the BoE was the news that core inflation rose from 6.2% to 6.8% per year over the same period. That news is likely to keep pressure on the BoE to continue raising UK interest rates, especially given the news that retail sales growth remains strong (see below). In fact, implicit market expectations now call for the BoE to raise rates by as much as another 75 basis points, before they likely reach their terminal rate. Bailey looks upset. On a brighter note, the IMF now agrees that the UK is set to escape a recession this year, according to its latest update. Having previously expected the economy to contract by 0.5% during 2023, the IMF has broken the script and now expects a decent 0.4% expansion over the year. That’s a big change in direction. The IMF also singled out the UK government for taking ‘decisive and responsible action’ to restore market and economic stability following the turmoil that followed Liz Truss’ ‘mini budget’. In other news, UK public sector net borrowing hit £25.6bn in April, above the OBR estimate of £22.4bn, driven by an increase in the cost of support schemes energy and high interest costs on debt, given the BoE’s continued rate hikes. The latest UK PMI data missed both in Services (from 55.9 to 55.1) and Manufacturing (from 47.8 to 46.9), with a big jump in prices in the Services sector, which which could add to the BoE’s inflation woes.

UK retail sales this morning (Friday) reflected a strong 0.5% rebound in sales over the past month, after declining 1.2% in March. Markets had expected a slightly smaller increase of around 0.3%. However, growth was even stronger excluding fuel, with a rapid gain of 0.8%, after declining 1.4% in the previous month.

The pound has had a mixed performance during the week. GBP/USD has struggled and dipped below 1.2330 for the first time since early April, largely driven by those strong dollar gains. However, the pound has generally fared much better, with GBP/EUR moving to 1.1550, marking the highest level for the pair this year, albeit briefly.

USD

It has been another week to forget for the single currency. A combination of a stronger dollar, coupled with weaker European economic data, has culminated in manifesting another leg lower for EUR/USD considerably. Having been as high as 1.1090 in early May, the pair has now eased back to just above 1.0700. That’s a pretty big hit in less than a month and brings us back to levels last seen in March.

As we mentioned earlier, the latest European data incoming has been a major factor in the single currency’s sudden decline. Germany remains front and center on negative news and, following weak manufacturing data, the latest GDP figures confirmed yesterday (Thursday) that Europe’s largest economy had entered recession*. Growth slowed by 0.3% during the last quarter. Markets had expected a flat reading for the period. The latest German IFO survey also disappointed, noting the first drop in seven months for both the business climate and current assessment components. Rounding out the dismal data set, PMI data also largely disappointed in Europe, with Germany’s manufacturing PMI slipping from 44.5 to 42.9. Markets had expected a slight improvement, albeit a long way from the key 50 threshold. However, there was better news among services, moving from 56 to 57.8 and helping push the composite up to 54.3. The scenario was repeated at the regional level, with a weak manufacturing context overshadowed by strong growth in the services sector.

Incoming European data next week may give the single currency a chance to correct some of the recent declines, with key inflation data set to take center stage. Of course, the higher the impression of inflation, the more aggressive the ECB could be expected to behave and thus fuel rising market expectations for further increases.

*Two consecutive quarters of negative growth are typically considered a technical recession