Sterling was a bit of a two-trick pony this week. There were the Purchasing Managers’ Indices and the Bank of England’s monetary policy announcement. Investors were not greatly surprised by anything they saw or heard. The BoE announcement had the greatest impact because its influence was not restricted to midday on Thursday: there was conjecture aplenty both before and after the event itself. On the whole, investors liked what they heard from the central bank and sterling was Thursday's top performer. On average, it was just about unchanged on the week, adding a third of a euro cent and losing a third of a US cent.
The PMI readings put manufacturing three and a half points lower on the month at 60.4 and services down by three points at 59.6. As expected, the BoE left Bank Rate unchanged at 0.1% by a unanimous decision, and only one member voted to reduce the scale of asset purchases. The bank does, however, foresee “some modest tightening”.
It was a case of could-do-better for the euro, which lost an average of 0.2% to the other major currencies and gave up a third of a cent to sterling. It was not that the euro did anything particularly wrong; rather, it failed to live up to the expectations of analysts, who predicted better results than Europe was able to deliver.
It could be argued that investors were unduly harsh in their treatment of the euro. In absolute terms, most of the economic data were good. Gross domestic product expanded by a provisional 2.0% in Q2, beating the forecast 1.5% growth. German retail sales went up by 4.2% in June, more than twice as much as expected. PMIs for manufacturing in Germany and the Eurozone were strong, though off their highs. The real problem lay in the services PMIs. Germany and the Eurozone both fell short of analysts’ forecasts. Although the composite measure showed Eurozone economic activity growing at the fastest rate since June 2006, investors preferred to believe that it should have been growing even more quickly.
Where investors berated the euro for its perceived failure to live up to their expectations, they gave the US dollar the benefit of the doubt on most counts. An underlying support for the currency is the suspicion that the Federal Reserve is not as averse to tighter monetary policy as its dismissal of “transitory” inflation might suggest. Vice Chairman Richard Clarida gave the impression in a speech that, by the end of this year, the Fed will be pointing to higher interest rates in 2023.
The US economic data did not all work in the dollar’s favour, and investors’ reaction was rather discriminatory. They focused on a weaker than expected ISM manufacturing PMI and completely ignored the equivalent measure from Markit, which came in at a record high. Two days later they did a similar thing, embracing ISM’s services PMI because it was a record high and turning a blind eye to Markit’s assessment that it was the “softest rise in business activity since February”. The US dollar came out of it reasonably well, adding an average of 0.2% and taking a fairly distant second place behind the high-flying NZ dollar.
The Loonie lost ground during the early part of the week and made a partial recovery later. It lost two fifths of a US cent and gave up half a cent to sterling. On average, the Canadian dollar lost 0.2% to the majors. Its rocky start owed at least something to last Friday’s Canadian ecostats. Gross domestic product contracted by 0.3%, after shrinking 0.5% in April. “Overall, 12 of 20 industrial sectors were down as both services-producing (-0.2%) and goods-producing industries (-0.4%) contracted.” At the same time, raw material prices (input) increased by a monthly 3.8%, while product prices (output) were unchanged. On an annual basis, raw materials were up by 38.1% and industrial product prices rose 16.8%.
Data released this week were less of a hurdle. The manufacturing PMI was very slightly lower on the month at 56.2, but the report noted “faster increases in output, new orders and jobs”. Building permits rebounded by 6.9% in June, after having fallen 12.9% the previous month. Canada’s balance of trade benefited from a record high in exports for June, which resulted in the biggest monthly surplus since November 2008.
The Aussie received better treatment from investors than in recent weeks. The Covid-19 pandemic continues to weigh on economic activity, but investors were encouraged by the Reserve Bank of Australia’s latest monetary policy statement. There had been a general assumption that the RBA would feel obliged to backtrack on last month’s decision to slow the pace of bond purchases to $4 billion a week in September. The argument was that new Covid outbreaks would have a dampening effect on the Australian economy, which the RBA could not ignore. But that was not how it turned out. In its statement, the central bank said it would keep the Cash Rate at 0.1% and “continue to purchase government securities at the rate of $5 billion a week until early September and then $4 billion a week until at least mid-November”.
There was not much support for the AUD to be found among the domestic economic data. Home loans, building permits and retail sales were all lower in June, largely due to Covid restrictions. The services sector sank into contraction for the same reason. However, investors were impressed that the RBA had stuck to its line with asset purchases, and the currency put in an above-average performance, strengthening by 0.2%.
There was one set of NZ economic data that mattered: Wednesday’s employment figures for the second quarter. Statistics NZ made no attempt to underplay the importance of the employment data, headlining its report “Sharp falls in unemployment and underutilisation”. The rate of unemployment fell to 4% in June, close to its lowest level in 13 years. The labour cost index rose by an annual 2.2%, still short of the 2.4% level seen in early 2020 but heading in that direction. A ten-year high for inflation and the Reserve Bank of New Zealand’s newish obligation to consider house prices when setting policy have combined to put pressure on the central bank to be seen to be doing something. Governor Adrian Orr said this week that the bank “needs to think about when and how we would return interest rates to more normal levels”.
Investors are now convinced that tighter monetary policy from the RBNZ is just around the corner, and that the first rate increase will not be the last. They might be over-optimistic about the speed and scale of the hiking process, but they are certain it will be good for the NZ dollar. The Kiwi left the major currencies in its dust, strengthening by an average of 0.9%.