ECB expected to stay on hold this week

Oil prices have headed north at the start of the week amid escalating hostilities between the US and Iran. Brent crude has risen to over $90 per barrel, bringing the cumulative increase over the past couple of weeks to around $20. Central bank interest rate expectations have hardened over the same period with the market pricing in an additional 25bps or so of hikes from the ECB and Bank of England by the end of this year. The ECB is expected to leave rates unchanged (at 2.25%) at this Thursday’s meeting though, albeit a 25bps increase is almost fully priced in for the following meeting in September when there will be updated inflation and growth forecasts to hand. In FX, the euro and sterling are holding in relatively well against the dollar notwithstanding recent geopolitical developments. Both gained some modest ground against the US currency last week and are trading at about $1.1450 and $1.3470 respectively this morning, while EURGBP is hovering around the £0.85 level. UK markets will be focused on political developments today as Andy Burnham becomes Prime Minister and announces his ‘pick’ as Chancellor of the Exchequer. There are also some important economic data due in the UK this week, including the latest labour market report tomorrow and CPI inflation for June on Wednesday.

German and UK government bond yields backed up last week, amid rising oil prices and hardening rate hike expectations, with 2-year yields increasing by the best part of 15bps. In contrast, US yields fell slightly on the week as softer than expected CPI and PPI inflation data led to some easing on Fed rate expectations (though the market is still pricing in more than 30bps of hikes by year-end). Meanwhile, equity markets remained under pressure on Friday with the Euro Stoxx 600 shedding almost 0.5% and the S&P 500 closing 1% lower on the day.

Fed member Hammack says “there is no conflict” in the central bank’s dual mandate, noting that “inflation is too high” and that, “for the first time in my tenure, I’m hearing from businesses who say they think we need to take action to curb inflation.”

In terms of economic data for the week ahead, as well as the UK labour market and inflation reports (Tuesday and Wednesday respectively), the other main releases of note are the flash PMIs for July in the main economies (Euro area, US and UK) and the ECB’s latest survey of consumer inflation expectations, all due on Friday.