Global FX & Economics: UK Outlook, GBP and SEK

Welcome to the J.P. Morgan At Any Rate podcast. I'm James Nelligan from FX Strategy.

I'm joined this week by Alan Monks, our UK economist, and Octavia Popescu, who was also with me in FX Strategy, looking at the European currencies. So we're going to focus on the European area this week, and particularly the UK outlook and sterling. But we'll also have some other things to say about European currencies as well.

So let's dive into it, Alan. We can start with you, particularly on the UK outlook. How are you seeing things at the moment?

Obviously we're drawing closer to the make or fail by-election vote next week. We seem to be in an environment where global central banks are kind of edging towards tightening policy. UK data has seemed a little bit resilient to us through the year.

How are you seeing things playing out at the moment and going forward over the next period of time for the UK in terms of the broader outlook? Yes. Thanks, James.

So I think it's a busy week next week as we've got the by-election and the Bank of England as well. So I think on the politics side, there had been a little bit of uncertainty a couple of weeks ago about how Burnham would fare in the make or fail by-election. Some of the polling was mixed, but I think as his campaign has got going, we saw that survey from poll last week that put Labour on a 10 point lead.

So it seems maybe you'd say 70, 80% chance that he wins that by-election. And then the next question will be, how quickly do you get a leadership challenge? He's indicated that he would push for one.

There was a couple of stories that were doing the rounds suggesting that he might delay a leadership contest in the hope that Starmer would kind of back down and you would have a sort of gentle handover period occurring in the background, so that might delay the transition to the next prime minister. But I think some of the more recent stories have suggested that Starmer would put up a fight here. I would still think there's a leadership contest that takes place, which if you had others contesting that, if Wes Streeting were to throw his hand into the ring as well, then I think it would be hard to see all of this done and dusted by July, which is probably the earliest you could think of.

If there's a sort of short campaign period with some debates and then the vote is put round to Labour Party members, then this could add about six weeks onto the process at least. So then you'd be looking at sort of late August or September. So that would be my timeframe over which this occurs.

I assumed that Burnham would win a leadership contest. The polling points very much in that direction. And then it is a question of how radical would he be after being put in that position?

And again, some people have suggested he wouldn't want to rock the boat in terms of large fiscal changes. Obviously, the markets are sensitive to suggestions that borrowing could increase. I guess there's been a lot of reassurances coming from Burnham recently saying that he wouldn't go for an early election, he'd stick to the fiscal rules, he'd stick to the Labour Party manifesto.

I mean, that's fine to say now, but I think it would create the danger that he falls into the sort of status quo sort of mindset and people obviously want some change at the moment. So I think there will be pressure for him to reconsider some of those pledges if he were to be elected. And I can see him taking perhaps a little bit more risk, managed risk in a run up to the next budget, which is not until the end of this year as a point I would make.

So probably an early election is unlikely this year, but if he got a big boost in the polls, which is something to watch out for in the next few weeks, then it might be something that's tempting. And yeah, I think maybe there is some scope for extra borrowing if that was managed and focused on investment spending. And he may be open to more sort of tax increases to try and remove the cuts in day-to-day spending that are in the plans at the moment.

So that's broadly where I think we might be heading. If you put this into a broader context, I mean, fiscal policy is tightening at the moment and it's planned to continue tightening for next year. I don't think that's radically going to change in the aggregate.

So you are looking at that growth drag, but you're right to say that I think the data on the whole this year has been fairly resilient in the face of the energy shock. It's still early days, but I would say there's a good start to the year. There's evidence of a slowing in the second quarter, but to me, it looks like it contains slowing.

I'd fade a little bit the very last PMI that we had and focus more on the average of the past couple of months. So I think when you're thinking about the Bank of England, how do they respond to this next week? I mean, nobody expects them to change rates next week.

I've still got a hike in for July. And I think in terms of the communications next week, I would expect to see a tightening in the vote, a closer vote on the MPCs, 7-2, 6-3, something in that ballpark. Obviously, they've got a bit of time on their hands.

Oil prices haven't risen as much as we would have expected. You've also got weakness in the labour market and a downside surprise that we had in the inflation numbers in April. So that buys them a little bit of time.

But I think the main concern at the moment would be that the base case is still that we'll be heading for inflation by the end of this year based on oil prices currently, which is about three and a half percent, maybe higher, three and a half to four percent. And that would be then going into the next wage round. And I don't think we've got any sort of clear or strong evidence of second round effects at this stage.

But what you do see, and this is probably what the main concern is for the Bank of England, is that a number of the kind of forward looking pricing surveys that we've got, DMP, PMI, pretty much across sectors and household inflation expectations, have been very responsive to this increase in energy. And I think that does put the Bank of England on alert for there to be essentially quite strong indirect effects, but the risk of second round effects through time. So with other central banks on the move as well, I do think they would continue to stick to a tightening bias.

And it's not completely slam dunk for July, but I still think it's more likely not that they go in that month as a forecast meeting from them. And that's based on the assumption that the inflation numbers will start to mimic some of the strength that we see in the pricing surveys. Maybe oil moves up a little bit from here.

So that's how I'd frame things in terms of the Bank of England outlook. But I think they would give only a modest tightening, reflecting the fact that rates still were high to begin with going into this. So that's very fair, Alan.

Thanks for that. I think thinking about sterling on the back of that, I mean, certainly in terms of the politics. I think, you know, along the same lines, really, it's quite important what happens in the days and weeks following the Makerfield vote rather than the vote itself for Sterling.

I mean, in terms of whether you do see any change in rhetoric from Burnham or capitalisation from him on, say, for example, a more significant victory at Makerfield, whether that kind of narrows the race or allows Burnham to talk a bit more about a snap election or allows him to, as you say, Alan, take a bit more risk in terms of the policies that he's going, he's advocating. That's something that might allow Sterling to price a little bit more fiscal risk premium. But as you say, the kind of the more base case is that we do move on to something resembling a more traditional kind of Labour leadership contest, which takes you more along the lines of a kind of August, September timeline, as you say.

And that just allows carry for the currency to be a bit more influential over a summer where it's going to be harder. It's looking like it's going to be harder for a full normalisation in energy prices, and that keeps carry currency supported in G10. And if you think about Sterling, particularly on the systematic side, it's really the only G10 currency where you've got the ability to earn carry without a super high sensitivity to terms of trade like you see with, say, Nokia or Aussie.

You know, I would say I think it's the it's the days and weeks following the vote next week that are important for Sterling. But what we've seen is Eurosterling grind down towards these key support levels just above 86. And I think that that is a function of the climb down in rhetoric from Burnham, enabling kind of carry short positioning, UK resilience to be a frustration for Sterling short positioning.

And we kind of set out a thesis back in April that we thought that would be the case in terms of the drawn out political process, just frustrating shorts and allowing carry to be a bit more influential. And we're kind of still of that view, really, for Sterling and on the Bank of England side, as you say, Alan, it's going to be more difficult for them to sound too hawkish next week. But we are conscious, as you say, that we're in an environment where global central banks are edging towards tightening or even even further than that.

And it might become a little bit harder for Bank of England to be too distant from that pack. And then if any kind of shift in Bank of England rhetoric along those lines, I think we'll just add to this kind of Sterling carry focus or frustration for short positioning. I think the strength in US data as well might allow Sterling to trade a little bit better in terms of just perpetuating that carry environment, given that US yields are a big determining factor for carry strategy performance in FX as well.

And on our systematic metrics, as I say, Sterling does have the highest G10 ranking. We have seen UK data surprises come off slightly over the last few weeks. But we do think that global resilience that you're seeing, that you've seen the global manufacturing PMI make new cycle highs, even in the face of an oil shock, favours, I think, that continued carry performance.

So we're still of the mindset that short positions in Sterling can be tested a little bit longer. But we do have one eye on how the tone of the politics may shift in the weeks after Makerfield. Turning to you, Octavia, in terms of the rest of Europe, we have had a bearish, stocky view in terms of the Swedish krona for quite some time now, particularly since the conflict broke out.

We did last week talk a little bit more specifically about Eurostocky as a pair in terms of hedging, risk off outcomes or thinking about a more hawkish ECB relative to the Riksbank. Is there anything in that space that has stood out to you at all this week or any of the currencies in the European space? Hey, James, we actually have a fair bit going on in Scandinavia generally this week.

So we've had both Sweden and Norway data plus the Swedish fund flow data for May that came out, and that's actually what stood out the most to me. The data showed that Swedish retail investors rotated sharply back into foreign and US equities in May and away from Sweden. And we had signs of that in April already.

And the reason we care about this for stocky is that it has tended to be quite correlated with relative equity momentum between Sweden and the US and Swedish foreign equity holdings by retails are very large. And late last year and in Q1, equity momentum was in Sweden's favor by a large margin. And there was a big repatriation by the sector, which we do think was a tailwind for stocky.

But that episode seems to be over for now since March, really equity momentum has turned massively against it. And as we saw now, retail flows appear to have followed. So this pillar has very much flipped from being a support to being a drag.

And that comes on top of stockies already unattractive carry in the face of higher global yields. And now the Swedish growth picture has looked a bit better of late. If we look at the latest data.

So there was the better PMI, the GDP indicator came in a bit stronger today, even if it's volatile. And we had a firmer inflation print last week. So we are mindful of that.

But I do think I don't think that is enough to turn the tide on stocky when all the other factors like equity momentum and the regional growth and fiscal story and carry remain unsupportive. And, you know, the latter is very much in contrast to Sterling, like you mentioned, or Noki. And in any case, we prefer Noki over stocky and the inflation print in Norway this week reinforced this carry advantage.

So that's that's that was the other data point that stood out this week. OK, thanks for that, Octavia. That concludes the podcast for this week.

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