The UK economy defies expectations and rose after two months of contraction, boosting the pound. The FTSE falls as investors look nervously to US inflation data.
· US CPI is expected to rise to 8.8%, a fresh 40-year high, which could lift USD and pull stocks lower.
· BoC is expected to hike interest rates by 75 bp, taking the overnight rate to 2.25%
· Oil remains depressed after falling 8% yesterday on demand outlook concerns.
UK GDP
The UK economy rebounded firmly in May, rising by 0.5% MoM after two months of contraction and well ahead of the 0% stagnation forecast. The stronger than forecast growth will come as a welcomed relief to the BoE as policymakers fight to rein in 9.1% inflation. Even so, the central bank still expects the UK economy to contract in Q2 and is expected to grow again in the October to December period. However, with inflation set to continue rising to 11%, a recession, two consecutive quarters of contraction, is looking increasingly more likely.
Following the release, GBP/USD trades 0.2% higher, rising above 1.19. The FTSE is less impressed and is set to open 0.4% lower.
US CPI
Attention now turns to US CPI data which is expected to show that inflation rose to a fresh 40-year high in May of 8.8% YoY, up from 8.6% in April as energy prices continued to advance last month. Meanwhile, core CPI, which excludes more volatile items such as food and fuel, is expected to fall to 5.8% YoY, down from 6%. While this is slowing, it isn’t slow enough.
Expectations are for the Federal Reserve to raise interest rates by 75 basis points in July, a move which is 90% priced in according to the CME FedWatch tool. The market has an almost 10% probability of a 100-basis point rate increase. Hotter than forecast inflation could see the balance swing further towards a 100bp rate hike lifting the king dollar higher while pulling stocks and gold lower.
EUR/USD is clinging to parity ahead of the release after dropping to 1.00 for the first time in 20 years yesterday.
BoC
The BoC is set to announce its interest rate decision later today, and expectations are for a 75-basis point rate hike, which would take the overnight rate to 2.25%. Given that inflation sits at a 40-year high and that inflation expectations have risen, lifting the chances of inflation becoming entrenched, something the central bank will be keen to avoid, the BoC will likely sound hawkish. In addition to the largest rate hike since 1998 and hawkish commentary, the BoC is also likely to downgrade the growth outlook. Let’s not forget that unemployment is also at a record low and the housing market is hot. Furthermore, Canada’s strong commodity sector means that the economy is more resilient than most.
USD/CAD has risen over 1.30 as the loonie tracked oil prices lower in the previous session.
Oil
Oil tumbled over 8% yesterday as the demand outlook deteriorated on recession fears and Chinese COVID-19 cases continued to climb. Oil fell to a low of $92.40, a 3-month low. Oil remains depressed today as it awaits the CPI data. Hot headline CPI could fuel aggressive Fed bets and lift the likelihood of the Fed pushing the US economy into recession, hurting the oil demand outlook further.
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