August Rate Hike in UK Back in Vogue

Wage pressures cited as Chief Economist votes for hike

Andy Haldane the Chief Economist of the Bank of England joined the “usual suspects”, Ian McCafferty and Michael Saunders in voting for a hike in short term interest rates in the U.K. from 0.5% to 0.75% at yesterday’s MPC meeting. This gave a slight boost to the chances of a hike in August and provided support for the pound which had earlier made a new low for the year versus the dollar of 1.3101. It recovered a little on the back of the news of a further dissenting voice closing at 1.3241.

It has rallied further overnight making a high of 1.3268 (04.30BST)

Haldane commented that he believes that several of the deals struck in the new round of pay negotiations will push wage inflation higher in the coming months. In normal circumstances, such thoughts would have possibly persuaded other members of the committee to follow, but with several headwinds facing the U.K. economy, a pre-emptive move is barely justified.

Versus the euro, the pound rose to 1.1459, its highest level in a week before settling back as the euro gained versus a weakening dollar (see below) to close at 1.1414.

The possibility of an August hike is also heightened by the weakening pound, which is sure to push up producer prices. This is seen as a precursor to a rise in consumer prices. It remains to be seen if inflation has bottomed out at 2.2, as seen in April, following a rise to 2.3% in May.

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Euro sceptics fill two important Italian Cabinet roles

The relief that followed the agreement between Italian Prime Minister Giuseppe Conti and the President Sergio Mattarella over the makeup of the Cabinet has dissipated as more members have been nominated.

Conti has named two extreme euro skeptics to head up finance committees that will drive through tax cuts and welfare increases. This will add a further burden to Italy’s already overladen debt to GDP ratio currently, running at 132%.

Economists in Brussels and Frankfurt have expressed concerns over the nationalist policies of the new Government and it had been hoped that once elected they would temper their more radical ideas.

This is unlikely to be the case and the resurfacing of concerns hit the euro yesterday which made a new 2018 low versus the dollar of 1.1508 before rallying, as the dollar weakened, to close at 1.1603.

Next week sees the release of Eurozone wide inflation data which will show a small rise as the currency has fallen, making imports more expensive. Analysts expect CPI to have risen, year on year, from 2.2% to 2.3% following a month on month rise of 0.8%

The ECB is comfortable with the level of inflation which it can attribute to a weaker currency since it also aids exports, bringing growth to the weaker economies.

Manufacturing Survey hits dollar

The dollar, which had been gaining throughout the weak from safe haven flows related to the heightening of a potential trade war between the U.S. and China saw a bout of profit taking yesterday driven by a weaker than expected survey of manufacturing activity released by the Federal Reserve of Philadelphia. There are several similar surveys released monthly, but it is the “Philly Fed” which tends to carry most weight.

Manufacturing activity fell from 34.4 to 19.9. There had been an expectation of a fall to 29 but such a large drop, which could be a one off, is a signal that President Trump’s tax cuts have not yet had the galvanizing effect that was expected. While it is too early for next week’s release of final Q1 GDP to show any effect from the tax reform, the market will be expecting to see a significant rise in Q2 GDP.

The dollar index had rallied to a new 2018 high of 95.53 driven primarily by the weakening euro but the tables were turned later in the day as the dollar took centre stage, falling to close at 94.88.

Data releases are reasonably light next week although along with Q1 GDP there is the release of Core Personal Consumption Expenditures for Q1. This measure of inflation is supposedly favoured by the Fed over CPI, which is more subjective, and any deviation from market expectations for a QoQ rise of 2.3%, unchanged from Q4, will have an effect on traders’ expectations for the timing of the next rate hike.