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As the latest data suggests, inflation in Europe reached 8.1%, significantly higher than April’s all-time high of 7.4%. As expected, the main driver of inflation was the increase in energy prices. Be that as it may, the market reaction was not long in coming: last week, the STOXX 50 index fell by 1.5%, while the DAX fell by 0.8%. The DXY dollar index, meanwhile, rose by 0.5% to 102.17.
The 29.6% rise in German 10-year bond yields, on the other hand, reflects market fears of a change in the ECB’s monetary policy. The regulator is expected to announce the end of asset purchases and pave the way for a rate hike in July. Incidentally, in the United States, the yield on ten-year Treasury bonds rose by 7.2% to 2.94% on the back of good labor market data and statements by Fed Vice Chairwoman Brainard.
Now it’s time to watch the May inflation report and the University of Michigan consumer sentiment index. If inflation shows signs of demand destruction, calls for a 50 basis point rate hike in September could subside.
On the geopolitical front, British Prime Minister Boris Johnson is threatening to change the protocol on Northern Ireland, saying the current mechanism is too cumbersome and hurts the British economy. There are also plans to remove Northern Ireland from the jurisdiction of the European Court of Justice and abolish EU competition and VAT rules in Northern Ireland. The UK government may introduce legislation to change the protocol, which would undoubtedly trigger retaliation from the EU.
Along with that, it is worth mentioning that a Conservative motion of censure against Prime Minister Boris Johnson will take place tonight, as announced by the head of the 1922 Committee, Graham Brady. To remain at the helm of the Conservatives, the chief of staff needs the support of half of the voters.
Finally, regarding the foreign exchange market:
- Turkish lira remains under pressure. Given the local central bank’s modest reserves, it will not be easy to stop further weakening. Meanwhile, consumer prices in the country soared 73.5% (YoY) in May. Perhaps the time has come to abandon unorthodox monetary policy?
- Japanese yen. Amid rising US yields and confirmation by Japanese officials of ultra-easy monetary policy by the Bank of Japan, USD/JPY is back above 130.
- Chinese renminbi. On Thursday, the vice president of the People’s Bank of China said that the regulator would use various policy tools to increase liquidity injections in order to maintain a sufficient level of liquidity. Citi analysts expect the yuan to weaken in the coming months.
