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, headline CPI thankfully slipped from double digits to 8.7% on an annual basis. However, markets had been expecting a bigger decline to around 8.2%. More worrying for the BoE, was the news that core inflation increased from 6.2%, to 6.8% on an annual basis over the same period. That news is likely to keep the pressure on the BoE to continue raising UK interest rates, especially given news that Retail Sales growth remains robust (see below). Indeed, market-implied expectations now see the BoE raising rates by as much as another 75bps, before they likely reach their terminal rate. Bailey looks ruffled. On a brighter note, the IMF now agree the UK is set to escape a recession this year, according to their latest update. Having previously expected the economy to shrink by 0.5% during 2023, the IMF have ripped-up the script and now expect a worthy 0.4% expansion over the year. That is a big change of 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’s ‘mini budget.’ In other news, UK public sector net borrowing reached £25.6bn in April, higher than the OBR’s estimate of £22.4bn, driven by an increase in the cost of energy support schemes and high debt interest costs, given those ongoing BoE rate hikes. The latest UK PMI data missed on both Services (down from 55.9 to 55.1) and Manufacturing (down from 47.8 to 46.9), with a big jump in prices for the Services sector, potentially adding to the BoE’s inflation problems.

This morning’s (Friday) UK Retail Sales reflected a sharp rebound of 0.5% in sales over the past month, having declined by 1.2% in March. Markets had been expecting a slightly less increase of around 0.3%. However, growth was even stronger if you exclude Fuel, with a snappy 0.8% gain, having declined by 1.4% during the previous month.

The pound has had a mixed performance over the week. GBP/USD has struggled and slipped to below 1.2330 for the first time since the beginning of April, driven largely by those strong dollar gains. However, the broader pound has fared much better, with GBP/EUR moving to 1.1550, recording the highest level for the pair this year, albeit for a short spell.

EUR

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 considerable leg lower for EUR/USD. Having been as high as 1.1090 at the beginning of May, the pair has now declined to just above 1.0700. That is a fairly big hit in less than a month and takes us back to levels last witnessed in March.

As we mentioned above, the latest incoming European data has been a big factor impacting the sudden decline in the single currency. Germany continues to remain front and centre of the negative news, and following on from weak manufacturing data, the latest GDP figures confirmed yesterday (Thursday) that Europe’s biggest economy had now fallen into a recession*. Growth declined by 0.3% over the past quarter. Markets had been expecting a flat reading for the period. The latest German IFO survey also disappointed, highlighting the first decline in seven months for both the Business Climate and Current Assessment components. To complete the bleak data-set, PMI data also largely disappointed in Europe, with Germany’s Manufacturing PMI slipping from 44.5 to 42.9. Markets had been expecting a slight improvement, albeit a long way away from the key 50 threshold. However, there was better news among services, rising from 56, to 57.8 and helping to push the composite up to 54.3. The picture was replicated at regional level, with a weak manufacturing backdrop eclipsed by strong growth in the services sector.

Next week’s incoming European data may give the single currency an opportunity to correct some of the recent declines, with key inflation data set to take centre stage. Of course, the higher the inflation print, the more hawkish one might expect the ECB to behave, and thus fuel increasing market expectations for future hikes.

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