UK Inflation Unexpectedly Reached Double Digits (First Time Since 1982) in July

Fundamental analysis of Forex market


A dramatic sell-off in core bonds marked today’s market action. A number of smaller events culminated an impressive move. Yesterday’s earnings by US retailers Wallmart and Home Depot set things in motion. They beat consensus, putting away most pessimistic growth scenarios. Today’s US retail sales flatlined for the headline numbers, but were more upbeat for the underlying trend (excluding auto and gas; +0.7% M/M). The retail sales control group, proxy for consumption in GDP calculations, even accelerated to 0.8% M/M. The data confirm the resilience of the US consumer amid galloping inflation.

This morning’s RBNZ meeting was a second eye-catcher. The New Zealand central bank, frontrunner amongst major central banks, hiked its policy rate as expected by 50 bps to 3%, but also signaled a more hawkish policy rate path ahead. This includes a higher policy rate peak (>=4%) and a longer period of time with a restrictive policy rate (first rate penciled in early 2025). The RBNZ meeting is a warning shot for investors betting that weak growth would soon sideline centrale banks in their inflation crusade.

Finally, and probably most importantly, UK inflation unexpectedly reached double digits (first time since 1982) in July. The data print put the onus back on price pressure following the July recession scare. Recall that the Bank of England accelerated its tightening cycle with a first 50 bps rate hike with BoE governor Bailey adding that markets shouldn’t take this for granted as becoming the new standard. Eco data would decide on the magnitude of future moves. Well, they have decided. Also taking into account yesterday’s decent UK labour market report. A similar sound came from the ECB and Fed gatherings.

We might see hawkish FOMC Minutes tonight against the background of the gloomy economic outlook. At least three Fed governors downplayed the possibility of pausing the rate hike cycle or thinking about 2023 policy rate cuts following last week’s US CPI print. US inflation decelerated more than expected, from 9.1% Y/Y to 8.5% Y/Y.

UK Gilts underperformed German Bunds and US Treasuries. The UK yield curve bear flattens with yields adding 24.5 bps (!) (2-yr) to 15.2 bps (30-yr). The UK 2-yr yield surged above the June peak, currently trading near 2.4%. UK money markets put the policy rate peak around 3.75% (currently 1.75%!) by May next year. German yields copy the yield move, though daily changes are “limited” to +14.2 bps at the front end and +6.8 bps at the very long end. The German 10-yr yield easily surpassed 1%, breaking out the downward corrective trend channel in place since mid-June and changing the technical picture. The US yield curve becomes more inverse with yields adding 8.6 bps (2-yr) to 4.9 bps (30-yr).

Sterling failed to profit from the interest rate advantage with EUR/GBP higher at 0.8425 in a technically insignificant move. EUR/USD in a same vein trades stable near 1.0160. Stock markets get a flashback to the tough ride ahead of June. The core bond sell-off spills into weaker equity markets with Europe losing up to 1.5% (German Dax) and main US indices ceding up to 1% (Nasdaq).

News Headlines:

Polish and Hungarian growth decoupled in the second quarter of the year. Hungarian GDP beat consensus by growing by 1.1% Q/Q (6.5% NSA Y/Y) whereas Polish GDP was weaker-than-expected, declining by 2.3% Q/Q (5.3% Y/Y). Neither country published details yet, but we expect net exports to be a huge drag for both. Poland is now probably headed for a technical recession. Other factors at play are likely the conflict in Ukraine and disappointing inflows from EU funds. Today’s surge in core bond yields continues to weigh on CEE currencies. EUR/HUF temporary approached 410 before falling back towards 405. The Polish zloty was local outperformer earlier this week, but can’t escape the laws of gravity this time. EUR/PLN rises from 4.67 to 4.70.

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