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What's Happening Today - July 15
Okay, I was wrong. I can admit it. I had predicted a 75 bps raise in the Bank of Canada overnight lending rate, and they surprised everyone by front-loading with a 1% hike. After being overtaken by the Fed in June, the Bank of Canada reclaimed its top gun status, with the highest policy rate among G7 countries and the biggest step in this tightening cycle, as it seeks to calm inflation fears. Exceeding most expectations, the overnight rate was raised by 100 basis points to 2.5% in what is the biggest increase by the Bank of Canada since 1998, and the highest level since 2008. The policy rate now sits in the middle of the estimated neutral rate range of 2-3%. In addition, the Bank will continue with quantitative tightening. The statement pointed to much higher inflation than anticipated, and rising inflation expectations and a higher risk of de-anchoring as a reason for front-loading the path to higher rates. The outlook is less favourable than anticipated in April, with growth revised down while inflation is revised up. The MPR GDP growth forecast was downgraded to 3.5% for 2022 (previously 4.2%) and 1.8% for 2023 (previously 3.2%). The inflation forecast was revised up significantly to end this year at 7.5% (from 4.5% previously) before easing slower than forecasted in April to 3.2% by end 2023 (previously 2.4%), still above the target range. With the Bank of Canada qualifying this larger step than anticipated as "front-loading", we still believe they could stop at 3%, but the risks that the peak reaches 3.25% have increased.
South of the border, retail sales bounced back in the U.S. in June, but much of the advance owes to higher prices. The 1.0% growth in total sales was a tick above the consensus, and added to a positive revision to the prior month (now -0.1% vs. -0.3% previously). Higher sales of gasoline, in line with the jump in prices, as well as vehicles and restaurants, boosted the headline. But even when excluding those categories along with building materials, the control group of sales posted a better-than-expected 0.8% pace of growth (vs. 0.3% consensus). However, that upside surprise was partly negated by a downward revision to the prior month (now -0.3% vs. 0.0% previously). The control group advance included a 2.2% climb in online shopping amidst mixed readings in other categories. Traders continue to weigh the potential impact of a more-hawkish-than-anticipated Fed at the upcoming July 27th Interest Rate Decision, particularly following Wednesday's US CPI data which showed no signs of a slowdown in price pressures, with a +8.8% estimate vs the +9.1% actual reading. With three Fed policymakers scheduled to speak today, markets will examine the rhetoric for any indication of a 100bps interest rate hike following the release of US Retail Sales and Michigan Sentiment data, and Wednesday's surprise 100bp hike from the Bank of Canada. Any uptick in the Michigan Sentiment report could weigh heavily on considerations for a 100bps hike.
European markets are trading higher, led by automakers and retail stocks. Bored with English politics? Let’s have a look at Italy. The return of Italian political risks adds to broad euro negatives, including gas supply. Yesterday witnessed Prime Minister Draghi winning the vote on a package of measures that provided economic aid to families and businesses. However, the lack of support from the 5-star party prompted Draghi to submit his resignation to President Mattarella yesterday. Draghi had previously stated that his unity government, in place since February 2021, would not continue should its populist coalition partner withdraw its confidence. As President Mattarella refused to accept Draghi’s resignation the parliament is now in a form of limbo. Draghi is set to return to the Parliament, to assess whether a viable government is still possible, on Wednesday. If Draghi cannot form a government, or perhaps more appropriately for Draghi, one with broad enough breadth, the risk of early elections comes into view, they are otherwise scheduled for early 2023. An election would risk the passage of key structural reforms plus it would risk compromising the passing of the budget. Both factors are integral to Italy gaining access to Covid recovery funds. Next week’s European Central Bank meeting is set to witness not only the first ECB hike since 2011, we still expect 25bps, but it should also witness the President revealing details of its new anti-fragmentation tool. The new tool is expected to be known as the ‘Transmission Protection Mechanism’. If TPM is to avoid potential legal challenges, including in the German Constitutional Court, it seems the ECB may need to pay heed to the Bundesbank’s concerns regarding the tool only being used ‘‘in exceptional circumstances and under narrowly defined conditions.’’
Next week sees a number of key United Kingdom data releases, including June CPI and retail sales. We would expect CPI to register a fresh high at 9.2%. However, we would note that core prices could witness their first back-to-back correction since May 2020. In terms of retail sales having seen the CBI distributive trade survey suggest that sales volumes were at the lowest level since March 2021, this suggests the probability of a weak retail reading remains sizeable. The combination of slowing consumption, the correction proving a function of rising prices, underlines the increasingly challenging policy backdrop for the MPC. Bank of England Chief Economist Pill talks of a ‘difficult trade-off for monetary policy.’’ In terms of the Conservative leadership race the final five candidates face two TV debates over the weekend. Candidates will be culled down to two prior to the start of the Parliamentary recess from July 21st. The final two will be voted on by Conservative members, estimated to be around 0.3% of the total electorate. The result of the leadership ballot is scheduled for September 5th, with the new Prime Minister set to be anointed by the Queen on September 6th. The debates may well focus on fiscal plans. A perpetuation of calls for unfunded tax cuts, amplifying discussion as regards so-called fantasy economics, underlines the scope for political negativity to continue to drag on the GBP. Mr. Sunak topped the ballot in the second round and remains a firm contender to replace former Prime Minister Johnson. I’m voting for Hugh Grant.
Asian markets closed mostly lower on the back of rising Covid-19 cases in China and weak GDP growth numbers. Shanghai authorities have now classified more than 30 districts as high risk which could lead to another lockdown. China's GDP growth rate year-over-year came at 0.4% in Q2, below market forecast of 1.0% and slowing drastically from a 4.8% in Q1.
Oil prices are higher amid prospects of less aggressive rate hikes but worries about a recovery in demand capped gains.
As always, give us a shout if you have any questions, or if you’d like to get together for a review. Please note that I’m away next week (not that I’m going anywhere), but the Team will be on deck to handle anything and everything while I’m “relaxing in my back yard” (aka tackling the chore list).