MHMarkets:UK inflation is high and the economy is weak, the ECB is expected to raise interest rates by 25 basis points in July

UK inflation remains the highest in the G10, while economic growth through 2023 will lag most of its peers. This justifies the forecast for GBP/USD to weaken. JP Morgan FX analyst Paul Meggyesi: “Even with fiscal stimulus, the domestic cyclical outlook will continue to weigh on the sterling outlook. At the same time, the BoE seems unlikely to contain the pressure on sterling depreciation on its own.”

The current year-on-year increase in the UK CPI will be close to 11%, confirming that the cyclical outlook for the UK economy remains grim and, in fact, the UK's cumulative growth over the next six quarters to 2023 will be the second lowest in the G10. Although the Bank of England has signaled that it is willing to accelerate the rate hike may raise interest rates by 50 basis points in August. But so far, the trade-off of raising rates at a more gradual pace appears to be here to stay, and as long as that is the case, sterling should remain out of touch with nominal policy. We recommend a defensive and bullish stance on the U.S. dollar throughout the year, given weak economic growth, high inflation, and tighter monetary policy.

Talk of an ECB rate hike is on the rise, only with a bit of confusion over the pace and timing. Markets are now pricing in a 25 basis point rate hike in July, but a rate hike of more than 25 basis points remains a problem. “Given the inflation outlook, it would be appropriate to start raising rates by 25 basis points in July. We should continue to raise rates by 50 basis points in September,” Estonian central bank governor Muller said on Sunday. Money markets are betting on June 2023 will raise interest rates by two percentage points.

That compares with just 173 basis points last Friday. The ECB's Vasle has said there could be more rate hikes in the fourth quarter after September. Beyond that, Vasle has been talking about inflation and the economy. He said the inflation problem was caused by the war because the EU was too dependent on Russia for energy. But on GDP, he said: “I don't think there's going to be a recession, in fact, I think there's a chance of a surprise.” He added: “The service sector is booming and the labor market is tight.”

Financial data and events to focus on today:

22:00 Monthly rate of US factory orders in May