Against a more uncertain global backdrop, the European Central Bank (ECB) has become the first of the major central banks to adjust policy, raising rates by 25bps (0.25%) to 2.4%. President Lagarde described the decision as “pretty obvious”, with recent developments, including rising geopolitical tensions and the closure of the Strait of Hormuz, contributing to higher energy prices and prompting closer attention to potential spillovers into the wider economy.
The decision was taken unanimously, with policymakers mindful of the rise in consumer prices to 3.2% in May. Following the meeting, the ECB raised its inflation expectations to an average of 3% through to the end of the year, before easing to 2.3% in 2027. The ECB previously embarked on a steep rate hiking cycle between 2022 and 2023 to tackle inflation following Russia’s invasion of Ukraine. However, with eurozone growth declining by 0.2% in the first quarter, the central bank appears likely to adopt a more cautious approach to further tightening. Market expectations suggest that rates could increase by a further 25bps (0.25%) by the end of the year.
The Bank of Canada (BoC) also met this week, holding rates steady at 2.25%. This marked the fifth consecutive meeting without a change, as it seems policymakers are less concerned about inflation becoming broad based. As a net exporter of crude oil, Canada has benefited from higher revenues during the ongoing geopolitical tensions in the Middle East. Governor Macklem acknowledged the contraction in economic growth in the first quarter, noting that the economy appears weak rather than in a recession. Attention is also turning to the upcoming review of the United States–Mexico–Canada Agreement (USMCA), scheduled for early July, with officials increasingly concerned about the potential economic impact, particularly given the likelihood of stricter trade restrictions from the US.
UK GDP figures released this Friday morning for April showed the economy contracted by 0.1% month on month. The reversal in growth, following two consecutive months of expansion, reflects the impact of the US–Iran conflict. Services output, typically the UK’s primary driver of growth, declined by 0.2% over the month. At the same time, rising petrol prices appear to have weighed on consumer spending, contributing to a contraction in retail activity after growth in the previous month. The Bank of England is set to meet next week, although a rate hike appears unlikely as policymakers continue to exercise patience.
UK Chancellor Rachel Reeves commented following the weak data, maintaining that Labour’s economic plan had been working prior to the geopolitical conflict, pointing to strong growth at the start of the year and signs that inflation was moving towards the 2% target. She argued that the UK is in a strong position to absorb the economic impact of the conflict.
Elsewhere, this week in the Houses of Parliament, Defence Secretary John Healey became the latest minister to resign under Prime Minister Sir Keir Starmer, albeit for different reasons to many others. His departure follows a prolonged dispute over military spending, with Healey arguing that the Prime Minister had failed to commit sufficient resources to ensure national security. Starmer had previously pledged to increase defence spending to 3% of GDP; however, current plans suggest it will only reach 2.6% by 2030, highlighting the challenges the government faces in allocating additional resources.
We’ve managed to avoid talking about the US this long, but this week saw inflation rise at its fastest pace in over three years, reaching 4.2% in May. This highlights the impact of the ongoing conflict, with inflation having started the year at 2.4% and on a downward trajectory. The rising cost of living is also increasing pressure on President Trump and the Republican Party ahead of the midterm elections in November. Despite Trump’s 2024 pledge to bring inflation down, both markets and households appear increasingly reluctant to take his word at face value.
The conflict between the US and Iran remains unresolved. At the start of the week, Iran launched a missile attack on Israel. President Trump stated that he had instructed Israeli Prime Minister Netanyahu to refrain from retaliatory action; however, Israel responded the following day. A continued exchange of attacks between the US and Iran has further undermined any ceasefire that had been in place. Efforts by Pakistan and Qatar to mediate a resolution are ongoing, although progress appears limited. By the close of trading on Thursday, President Trump claimed that further attacks on Iran had been halted, with the final terms of a deal expected to be agreed in the coming days. Despite numerous false claims regarding a deal, markets did take Thursday’s announcements positively, with risk assets and precious metals rebounding strongly after weakness during the previous days.
Nathan Amaning, Investment Analyst
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