Economic Highlights

Last week saw the release of Purchasing Manager survey data around the world and it made for sobering reading. The prints for July missed expectations across the board in Europe and the US, with German Services and Manufacturing PMIs lurching into contractionary territory (both at 49.2). The US Services data was even worse, falling 5.7 points to 47.0, a full 5.6 points below consensus and one of the biggest misses we can recall in recent history. Within the US mix, there are signs that inflationary pressures are rolling over, but the expectations component was at its most negative since March 2021 and the report highlights a level of activity consistent with a 1% decline in US GDP. The one pair of data points that didn’t disappoint were the UK’s, both Services and Manufacturing remaining in positive territory (53.3 and 52.2) and meeting expectations. Maybe that’s a bigger surprise in the context of the other prints.

Before the PMI surveys landed, there was plenty of much less consoling data reported. Although rising inflation is hardly a surprise now, the headline print of 9.4% year-on-year for June was once again higher than expectations and at a 40-year high. For the optimists, the core rate ticked lower again to 5.8% as expected, down from April’s peak of 6.2%, but uncomfortably high nevertheless. All eyes are now on the Bank of England’s next rate-setting meeting on 4 August, with the market pricing in a 90% probability of a 0.5% rise in the base rate, a view which Governor Bailey seems happy to encourage. The effects of higher inflation could also be seen in the government’s finances for June, where the interest bill alone was £19.4bn thanks to the inflation-matching element of Index-Linked Gilts. This will only get worse when energy price caps are lifted again. It will be interesting to see whether this potential constraint influences the policy promises of the prospective leaders of the Conservative Party. One better piece of news came from the employment market, with 296k jobs created in the three months to May (forecast 170k). But if such numbers persist, it will only encourage the Bank of England to tighten policy more aggressively.

The housing market continues to decelerate, with Housing Starts, Mortgage Applications and Existing Home Sales all lower than expected (although Building Permits were better than forecast). Although still marginally above the 50 mark which delineates good from poor conditions, the National Association of Homebuilders’ Index reading of 55 is back to levels last seen during the recovery from the financial crisis (excepting Covid). While we continue to believe that a combination of market structure and demographics will not lead us to a repeat of the housing crisis of the noughties, a very sharp slowdown is underway and this will make itself felt through the rest of the economy. Regional Federal Reserve Board surveys are a useful indicator of activity and those from Philadelphia, Chicago and Dallas all disappointed versus expectations. The expectation is that the Federal Reserve Board itself is still expected to raise the Fed Funds rate by 0.75% this week.

There were two important macro events in Europe last week. First was the confirmation that Mario Draghi was resigning as the Italian Prime Minister. Political commentators suggest that Draghi is likely to remain in place as a caretaker Prime Minister, with an election likely in the Autumn. Past elections have tended to see volatility rise in Europe, owing to uncertainty about a new government’s loyalty to the EU, but principally because of the country’s high debt burden. The resignation of Draghi was unfortunately timed as it occurred on the same day the European Central Bank surprised the market with a 0.5% rate increase. Importantly, the central bank also withdrew its forward guidance commitment, with the statement reading that the governing council is transiting to a meeting-by-meeting approach in relation to its interest rate decisions. In effect, the path of Eurozone interest rates is now largely going to be data dependent, which increases uncertainty and, as a consequence, volatility in the rates market. The European Central Bank (ECB) also announced a new anti-fragmentation tool called the Transmission Protection Instrument. The purpose of this tool is to stop the bond yields of any member countries from moving into territory that would make that country’s financial position potentially unsustainable (with Italy the current favourite to be the first beneficiary). The ECB stated that the TPI is not restricted ex-ante, making it more likely that the central bank won’t actually need to use the tool given its unlimited size. But don’t bet against markets testing that supposition at some point.