This week's five highlights

Figure: Key euro area variables under the baseline and alternative scenarios (%)   

Lagarde disclosed that some ECB board members considered a hike at today’s meeting and she noted that the consensus was to wait for incoming data before the September 10 meeting and then reassess. This clearly signals that the September meeting will seriously consider a 25bps hike, but she was less hawkish elsewhere and highlighted that the Straits of Hormuz and energy prices are big swing factors.  Given the wage inflation trajectory, little sign of 2nd round effects, tight financial conditions, plus Trump’s bias to lower gasoline prices (and a renewed ceasefire) we attach a 50% probability to a hike at the September meeting rather than the 70% discounted in the money market.     

The ECB remained hawkish, despite some recent data including the June HICP inflation figure.  The ECB statement felt more comfortable on Q2 GDP, but the interpretation of the labor market data is that a softening is currently underway. On inflation, Lagarde in the statement acknowledge that wage inflation and labour cost index are coming under control, which we feel that lagged effect of the economy slowing and also financial conditions being tighter than the level of the ECB depo rate.  Even so, 1st round inflation effects are clear and will get worse in July with the renewed surge in energy prices.

Figure: 10yr Gilt v U.S. Treasuries and BOE-Fed Funds (%)

Apprehension exists over new UK PM Andy Burnham’s government fiscal policy.  While Burnham has reiterated yesterday his commitment to the fiscal rules and also suggested a little tax rise to pay for cost of living breathing space, markets remain nervous that political pressure will see fiscal slippage.  This morning’s scrapping of VAT on electricity (£850mln 2026/27) is funded by scrapping digital ID's, but shows the political pressure the government is under. Nevertheless, this is not acute and the 10yr UK-U.S. Treasury spread is only mildly elevated compared to the 2022 period when yields spiked much more than the BOE-Fed policy rate spread would suggest (Figure).

The appointment of John Healey is mixed.  While being a credible cabinet minister and good communicator, he has championed higher defence spending and may not have the political strength to block fiscal slippage from other cabinet ministers.

Work will begin in earnest now for the autumn budget, with some reports that the Burnham government would also like to review spending targets at the same time.  A honeymoon period does provide scope for the new government to differ compared to the Starmer administration, but this is restrained by UK politics and a more centre left administration under Burnham than under Starmer.  Some of this can be seen in comparison to the IMF and OECD UK reviews that have just been finished.  Both recommend reducing the overgenerous triple lock rule for state pension increases, but this is likely to be politically too difficult before an expected 2029 general election.  The same holds true for a land value tax/reform of property taxation and significant reform of disability benefits.   These measures are important for the 2030’s and 2040’s when the UK fiscal trajectory deteriorates due to population aging and associated health/pension and disability spending increase.

June industrial production has seen a second straight subdued month to follow a strong April, still leaving a healthy underlying picture but may temper some excessive optimism over the impact of rising AI-led investment. Industrial production increased by 0.1% on the month with mining and utilities both up by a moderate 0.4%, but manufacturing output was unchanged after rising by 0.1% in May and 0.7% in April.

Excluding gains in autos, manufacturing output fell by 0.1% after a flat May and a rise of 0.7% in April. Business equipment actually fell by 0.4% in June but after gains of 0.9% in May and 1.7% in April still looks strong in Q2.

Cautious trade has given way to a test of support at 101.00, where fresh buying interest is prompting fresh consolidation. Intraday studies are under pressure, highlighting room for a retest beneath here. But rising daily readings should limit any break in renewed buying interest/consolidation above 100.75. In the coming sessions, cautious trade is expected to give way to fresh tests higher, with focus to turn to the 101.33 weekly high of 13 July. But mixed/negative weekly charts should limit any immediate extension beyond here in consolidation within the 101.50 - 101.80 strong barrier. Meanwhile, a close below 100.75 would add weight to sentiment and open up a deeper retracement towards the 100.35 weekly low of 15 July.

Break above the 163.24 Tuesday's high has seen extension to fresh multi-year high to tag the 164.00 level. Bullish gains from the April low keep pressure firmly on the upside and suggest scope for break higher. Beyond this, will see scope to retest 164.55/164.95 highs of November 1986 and the 195.00 figure. Meanwhile, support is raised to the 163.24 and 162.84 recent highs which should now underpin. Would take break of these to ease the upside pressure and see room for consolidation to support at 162.00 and 161.28/00 area.