Three things to watch on Friday

Three things to watch on Friday

The UK consumer bounces back, as public finances remain tight for a potential new Labour government in the UK

It’s been a mixed bag for asset prices this week. Stocks are set to close the week higher after a strong rally for risk on Thursday. A surprise rate cut from the SNB and signs that the BOE will cut rates in August, turbo-charged risk assets on Thursday. The Eurostoxx is expected to eke out a gain this week, while the FTSE 100 is on track to close the week up 1.3%. The S&P 500 has made multiple record highs this week, however, it faltered on Thursday, which could be a sign of high-performance fatigue. We assume that the S&P 500 will continue to rally to fresh records, but two record high closes in a week is possibly enough for investors right now. Added to this, oil prices are higher by more than 5% in the past week, and Brent crude is back above $85 per barrel, which may take the edge of the stock market rally in the short term. Below we look at three themes to watch on Friday.

1, UK consumer bounces back in May - is it the Taylor effect?

UK retail sales surged last month, and core retail sales that exclude auto fuel rose at a 1.2% annualized pace in May, after falling by 2.5% in April. The ONS said that sales rebounded after a wet April, and sales volumes grew across most sectors, with clothing and furniture sales rebounding strongly. Could this be the Taylor Swift effect, with people (including myself) splurging on new outfits ahead of her era’s tour, the UK leg of which is set to add £1 billion to the UK economy?

There is no denying that this report paints a positive picture for the UK consumer. Non -food store sales rose by 3.5% in May, the highest level since April 2021, and online sales surged by 5.9%, the highest monthly increase since April 2022. The ONS did caveat the boost to sales compared to a year ago, by reminding us that last May there was an extra bank holiday for the King’s Coronation. However, after a slump at the end of spring, the consumer looks to be back as the UK finally moves towards summer. This boosted the pound, after its post BOE sell off on Thursday. However, sentiment towards GBP remains weak, and we think that GBP/USD will struggle to get back above $1.27 before the UK election on 4^th July.

Why isn’t the good news boosting the Tories?

Interestingly, a boost to the economy and a strong consumer ahead of an election is usually good news for the incumbent party, especially with the prospect of a near-term interest rate cut is thrown in for good measure. Not so for the Tories, who remain in the doldrums polls wise and are expected to see a massive wipe out and a mass loss of seats at this election.  The UK electorate are unwilling to ascribe the good economic data to the Conservatives, and this is also weighing on their chances in this election.

2, UK public finances – a tight spot for the next government

The UK public finance data for May was also released on Friday, public sector net borrowing was £15bn, which was slightly lower than the £15.1bn expected, and public sector net borrowing in May was at the highest level for the month of May since 2021, during the pandemic. A jump in borrowing ahead of an election is not unusual, however, with massive focus on the public finances across the English Channel in France and elsewhere in Europe, the UK cannot continue to spend without recourse. This leaves the Labour Party, who are on course to win this election with a massive majority, in a tight spot since they have made protecting the public finances a main part of their election pledge.

Some of the boost to spending was down to inflation linked increases in net social benefits, which rose by £2.5bn compared to a year ago to £25.1bn on the month. There was also a £0.2bn increase in the interest payable on central government debt, as high interest rates continue to rack up a large interest bill for the state.

Central government receipts from taxes etc. were £76.8bn last month, £1bn more than a year ago, as the increase in taxes rose by £2bn compared to last year. We really are seeing the effects of the highest tax burden in the UK for decades. This highlights how big the state’s spending needs are, and it is something that the market will be watching closely.

Overall, the next UK government needs to keep control of public spending as the bond vigilantes are never far away. UK bond yields are set to close the week lower, after the BOE meeting on Thursday was seen as opening the door for a rate cut from the BOE in August. The 2-year yield is currently 4.15%.

3, The yen: intervention risk rises

Inflation is in focus, for most of the world we are watching disinflation take hold so that central banks can cut rates, not so in Japan. Friday’s national CPI release was expected to give a green light to a rate hike in July, however, inflation surprised on the downside. National headline CPI rose to 2.8% in May from 2.5%, however, core CPI slipped back to 2.1% last month from 2.4% in April. Added to this, there are signs that the Japanese economy is losing some steam. The Jibun Bank PMI reports for June were weaker than expected. The composite rate fell to 50.0 from 52.6 in May, and the service sector report fell into contractionary territory at 49.8 vs. 53.8 a month ago. This has had an immediate impact on the yen, and USD/JPY surged to 159.00 at one point on Friday, it is currently trading just below this level, which may trigger official FX intervention to strengthen the yen. While the BOJ will likely hike rates next month, the BOJ will not want to spook the domestic economy by sounding too hawkish, which is weighing on the yen.