LLOYDS BANK ee THE WIRE: ECONOMICS KEEPING YOU CONNECTED TO THE MARKET Friday 29 July 2022 BOE AND US PAYROLLS IN FOCUS AS BOND YIELDS FALL = Market expectations for US interest rates tumble despite another Fed rate hike = Payrolls to provide key steer on US economic conditions after GDP decline prompts recession talk = BoE likely to raise rates again but extent of the increase is uncertain; markets are discounting a 50bp hike = BoE expected to raise its near-term inflation forecast but still predict sharp deceleration next year PAYROLLS EYED AMID CLAIMS US IN RECESSION RECAP OF THE WEEK ‘Slowing, or even falling, economic growth has been the dominant theme in markets this week. That was the case even ahead of Thursday's announcement that the US| # US Federal Reserve raised economy had contracted for @ second successive quarter in Q2, That news interest rates by 75bp, its prompted claims that the US was now in a ‘technical’ recession even though US fourth consecutive increase policymakers asserted that the weakness was not broad based, In marked contrast, Eurozone GDP unexpectedly accelerated in Q2. = US GDP dropped by 0.9% (annualised) in Q2, a second {A day before the US GDP data, the Federal Reserve raised interest rates by 75 consecutive decrease basis points, which means that policy rates are now 225bp above the start of the year. Moreover, while the policy update acknowledged some recent signs of |" The Lloyds Business weakness, the Fed re-asserted that high inflation was the big risk. In the press Barometer headline index fell conference, Fed Chair Powell pointed to the Ikellhood of further rates rises by 3 points in July taking it including the possibiliy of either a SObp or 75bp rise in September. below its long-run average Despite the Fed's comments, market expectations for US interestrates have fallen | #" Eurozone GDP rose by 0.7% sharply. US bond yields are down by close to 85bp from thelr June peak, prompting in Q2 up from 0.5% in Q1 declines elsewhere, including in UK gil yields. Markets stil think that US rates will rise further but by less than they did previously and expect the Fed to be forced to change direction next year. This raises the possibilty that market expectations may have fallen by too much if Fed policymakers maintain their current hawkish stance. = Eurozone annual CP! inflation rose to 8.9% in July up from 8.6% in June The US labour market ropot i a ey batts of 1 The Fee's preferred inflation \@ US labour market repor is always seen a8 a key beliwether of economic ition conditions. However, agaist his background, both next Friday's release for Jy, measure rises to 6.8% in June and the August report will be particularly important. In his latest comments, Fed (6.3% May); ‘core! rate up to Chair Powell desrived the labour market as stil strong and played down the 4.8% (rom 4.7%). Chart 1: Markets expect sizeable further UK rato risos Chart 2: BoE s« 3s inflation first higher but thon down UK Bank Rate pri 50 ing per meeting (bp) UK CPI Forecasts, yly % change ae 12 J — current inf novas.8 10 Estimates (May-22) 8 5 — toyd Bank oi Forecasts 24 vecz2s 6 ad 104 aug Sep Nov Doe zora ' 2020 ' 2021 | 2022 ' 2028 ' 2024 2025, ros: ont Massbon ot 200712 Saree Ween BO72 Ann Communication 1/6 COMMERCIAL BANKINGsignificance of recent rises in jobless claims. On that basis, any sign of weakness Innext Friday's labour market report willlend supporto the bond market rally, while a solid report may question the extent of the recent fallin interest rate expectations, We expect employment growth to have slowed again but stil suficiently strong to 'be more consistent with the latter view. Other important key indicators next week include the ISM surveys of manufacturing and services for July. These should provide important insights on the extent to which supply constraints are continuing to disrupt activity alongside a timely update on demand conditions. BOE TO TIGHTEN BUT BY HOW MUCH? In the UK, the key event of the week will be the latest update from the Bank of England's Monetary Policy Committee (MPC), A sith successive increase in Bank Rate is widely expected, but there is some uncertainty aver the size of the move. While our base case forecast is for another quarter-point rise, there is a strong chance that the MPC will deliver a larger increase of S0bp and markets appear to bee almost fully discounting such an outcome. {At Its update in June, the MPC paved the way for this by replacing its previous forward guidance with a more flexible commitment tobe “alert fo indications of more persistent inflationary pressures” and to “act forcefully in response.” The BoE's Chief economist, Huw Pill, later added that “at least on my part, this statement reflects a willingness — should circumstances require - to adopt a faster pace of fightening.” Governor Andrew Bailey has also nated that “a 50-basis point increase will be among the choices on the table* albeit such a move “is not locked in’ However, while such comments do indeed suggest that the MPC may be planning to pick up the pace of tightening, the cue provided by recent data makes it less Clear cut. CPI inflation was higher than expected in June but that was primarily due to imported prices rather than domestic pressures. Meanwhile, the latest labour ‘market report showed a noticeable softening in headline earings growth in the mths to May. GOP admittedly rose by more than expected in May but that primarily reflected ‘Jubilee distortions’ for which there will be payback in June, More broadly, the softening in confidence measures, both at the business and consumer level suggest that the downside risks to GDP growth across the second half of the year have increased. Nevertheless, with three members of the nine-strong committee expected to ‘maintain their previous calls for a 50bp hike in Bank Rate, the risk of at least two ‘more joining them, and thus delivering such an outcome, seems high. If the MPC Were to deliver a S0bp hike, however, we would view this as them frontoading their tightening rather than a sign that they believe rates need to rise by more than previously indicated, In addition to the policy rate announcement, we expect the BoE's updated forecasts to again highlight that market-based measures of interest rate expectations, which currently see Bank Rate peaking around 2.75-3.00%, are excessive. Notably, while the BoE will probably tits expectation again for the near-term peak in inflation, to around 12% (in October), we expect their forecasts conditioned on the market- implied interest rate path to show inflation moving below 2% in the medium term, potentially by more than shown in the forecasts from May. Meanwhile, the BoE's GDP growth forecasts for 2022 and 2023 are also likely to be downgraded, not least due to the more persistent hit to households’ spending power from higher inflation, Finally, the MPC will also provide an update on its strategy for ‘active! git sales. It ‘seems likely that a vote to commence such sales may take place at the September MPC meeting, which would pay the way for them to potentially begin in October. ‘The MPC may confirm that on Thursday and give some indication ofthe intended pace of selling, atleast for the near term, COMMERCIAL BANKING UPCOMING GLOBAL HIGHLIGHTS. China ‘official’ PMI manufacturing & non-manufacturing (Sun) China ‘Caixin’ PMI manufacturing & services (Mon & Wed) Eurozone PMI manufacturing & services (Mon & Wed) Eurozone unemployment rate (Tue) Reserve Bank of Australia policy update (Tue) New Zealand labour market report (Tue) Eurozone PPI (Wed) Eurozone retail sales (Wed) Canada labour market report (Fri) UPCOMING UK HIGHLIGHTS PMI manufacturing (Mon) PMI services (Wed) PMI construction (Thu) BoE policy update (Thu) UPCOMING US HIGHLIGHTS Construction spending (Mon) ISM manufacturing (Mon) ISM services (Wed) Factory orders (Wed) International trade (Thu) Labour market report (Fri) Marketing Communication 2/6