Weather Boosts Growth but Questions Remain Beneath the Surface: Sterling Update

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Market conditions have not altered materially over the weekend, despite some concerning developments in the Middle East. In its first official response to the US’s 15‑point plan for Gaza, Israeli Prime Minister Netanyahu categorically rejected the proposal. He stated that Israeli forces would not withdraw from Gaza until Hamas was “genuinely disarmed”.

Meanwhile, a resumption of cargo and tanker transit through the Strait of Hormuz appears unlikely given the latest demands from the Iranian regime. Previously, Iran had called for ships from the US and other nations it considers aggressors to be barred from navigation, while other nations would be required to pay a transit tariff. That position now appears to have shifted, with Iran calling for an end to the US blockade and the payment of compensation before the Strait is reopened.

Such demands are unlikely to be accepted by the US and, although oil prices have shown little reaction to these developments, further downside in energy prices appears unlikely at this juncture, in my view.

Monthly and Q2 UK growth figures in focus as hot weather influences activity

This week sees the release of the UK’s June and Q2 GDP figures. The consensus forecast is for Q2 GDP growth of 0.4%, matching the Q2 growth rates already recorded in both the US and the Euro Area. The strength in GDP appears to be driven by one off factors, with UK consumer spending supported by hot weather and the World Cup. Neither factor is likely to prove lasting, nor do expectations of higher UK interest rates appear well supported given the underlying weaknesses in the labour market, private sector earnings, and the construction and agriculture sectors.

Hot weather is likely to have supported stronger GDP growth in Q2, with increased sales of fans and air conditioning units providing a boost. However, the monthly breakdown may show a sharp slowing in activity towards the end of the quarter. Services growth is expected to have flatlined, while industrial production remains subdued at best.

GBP continues to hold up while other economies contend with their own challenges, but the current weakness in the USD may well prove temporary.

US focus on CPI after substantial payrolls miss

July’s US non‑farm payrolls report was, in short, awful. Net payrolls fell by 23k compared with June, while revisions to the previous two months removed a further 103k jobs from the total. Labour force participation also declined and average earnings growth moderated. The only positive was a fall in the unemployment rate, although that was driven by lower labour force participation. The data prompted a decline in the USD, allowing GBPUSD and EURUSD to advance.

Notably, however, the JPY saw only limited and temporary support. The difficulty the currency is having in holding on to its recent intervention‑driven gains suggests the authorities may need to consider something more permanent if they are to alter the JPY’s direction of travel.

The focus this week shifts to July CPI inflation and, later, July retail sales data. CPI inflation is expected to ease on both the headline and core measures, with lower energy prices during much of the July measurement period likely responsible for weaker headline inflation.

As for retail sales, high temperatures and the World Cup may have supported spending beyond current expectations. Areas of strength could include electrical goods, fans and air conditioning equipment, clothing and footwear, and seasonal food products. In my opinion, there should be little in either release that materially undermines the USD further.

It is a relatively quiet week for Euro Area data releases. The main focus is likely to be June industrial production figures, due on Thursday. Consensus expectations are for production to have flatlined in June following a 0.2% month on month decline in May, but whether the figures can outperform remains unclear.

Signals from individual sectors would suggest not. The automotive sector continues to face pressure from Chinese production and discounting as those manufacturers attempt to reduce excess inventories. That continues to weigh on export markets, particularly in countries such as the UK. Construction also remains under pressure, while the broader economy looks set to struggle against the backdrop of US tariffs and trade quotas.

With the ECB now in its summer hiatus, there will be no public commentary from ECB officials until they return. That leaves FX markets vulnerable to developing a fresh narrative around economic weakness and to reducing expectations for further monetary tightening. Even if the ECB does sanction a rate hike, I am not convinced it would materially help either the EUR or the wider economy over the medium term.

Both the CAD and MXN strengthened against the USD following last week’s US non‑farm payrolls report.

For the CAD, domestic employment data were considerably stronger than expected. However, the picture was not entirely positive, with hourly wage growth slowing to just 3.0% year‑on‑year in July, the weakest reading in more than four years. In my opinion, the case for higher Canadian interest rates remains tenuous. Attention will turn to July CPI inflation data, due on Monday 17 August. Should those figures show signs of weakness, they could cut the wind from the CAD’s sails once again.

As for the MXN, the case for further peso strength appears less convincing. The Mexican central bank left interest rates unchanged at 6.5%, yet the data released around that decision suggest there is at least an argument for considering further policy loosening. Inflation continues to decline, consumer confidence remains weak, and vehicle production and exports remain under pressure.

This week’s industrial production figures could also disappoint, which may prevent USDMXN from breaking lower. The current weakness in the USD may well prove temporary.

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