Stagflation risks in full view
Stagflation risks come into sharp focus as rising energy prices, persistent inflation pressures, and slowing growth signals continue to shape FX market direction.
USD
Thursday brought the stagflationary mix into full view. A twelfth consecutive day of US-Iran strikes and Houthi attacks on Saudi tankers, which threaten to close the Bab el-Mandeb strait even as Hormuz shipping sits near a standstill, sent Brent above $100 for the first time in two months, with WTI settling above $90. President Trump's threat of a massive attack on Iran, exceeding anything prior, deepened the risk-off tone: 10-year Treasury yields rose to 4.70%, the Nasdaq fell over 2%, and the dollar firmed, if unevenly, with reports that officials are exploring grounds to remove Fed Governor Barr keeping independence concerns alive. Jobless claims at 187k, the lowest since 1969 against the 214k consensus we had flagged, challenged the softening-growth story that underpinned the modest dollar slide we argued for in Friday's Week Ahead. Overnight, Iran rejected a ceasefire proposal delivered by Iraq's PM and strikes entered a thirteenth night, yet the greenback trades marginally softer this morning. With the Fed in blackout before a July 29th decision that looks unusually unpredictable, focus today falls on flash PMIs, new home sales, and the 10-12.5% tariffs on 60 trading partners taking effect.
EUR
As anticipated, the ECB held the deposit rate at 2.25% on Thursday, and the statement's insistence that the Council is not pre-committed to any rate path initially nudged the euro lower. The press conference then delivered the hawkish emphasis we had expected: Lagarde dropped Sintra's judgement that inflation risks had become more balanced, revealed that some governors questioned whether a hike was already warranted, and, with Brent breaking $100 mid-presser, called the Bank's mild scenario quite unlikely, with inflation now seen above target into the first half of 2027. In our view this stopped just short of green-lighting the September hike markets price. Yet, consistent with our warning that prospects beyond the meeting looked more mixed, hawkish signals were overwhelmed by the terms-of-trade shock and broad dollar strength, EURUSD closing at three-week lows, the floor of its range since late June. The single currency steadies this morning ahead of flash PMIs, the first broad read on July activity since the renewed Hormuz closure, with June's composite having sat at 50.0. A soft print would crystallise the growth drag we expect to weigh on the euro absent de-escalation in the Gulf, keeping rallies capped near-term.
GBP
Sterling's slide extended on Thursday, with cable down a sixth straight session, its longest losing streak in nearly nine months, testing support around 1.33 as Chancellor Healey's pledge of disciplined control over the public finances failed to fully repair the damage done by Prime Minister Burnham's fiscal-rule flexibility comments. This morning's data offer relief, however. June retail sales volumes jumped 1.0% against consensus for a 0.3% fall, as the heatwave and World Cup lifted spending on cooling appliances, clothing, and food and drink, echoing recent signs of steadier consumer sentiment, and cable has ticked up from yesterday's lows. That said, as we cautioned after Wednesday's soft CPI print, June's readings flatter conditions that predate the Gulf ceasefire's July 8th collapse; with Brent above $100 and Ofgem's cap rise landing, the household squeeze should reintensify. None of this changes the picture for the MPC, which we expect to hold Bank Rate at 3.75% next Thursday, with markets pricing just a 4% chance of a hike but a full move by November. Ahead of that, flash PMIs at 09:30 BST are the next test, June's composite having slipped to 49.3, and we retain a modest downside bias pending Budget detail.
CAD
The loonie showed further resilience on Thursday. USDCAD ended little changed as a 6% surge in WTI offset broad dollar strength and the sharp deterioration in risk appetite. May retail sales matched the 1.0% consensus we had highlighted, with core sales up 0.9%, volumes 0.3% higher, and a 0.4% advance estimate for June, evidence of a consumer holding up despite tariffs and war-driven price pressures. As with Monday's soft CPI, though, we doubt this moves a Bank of Canada that held at 2.25% for a sixth time on July 15th and which we believe is done tightening. Trade remains the wildcard: Prime Minister Carney said Canada is focused on a comprehensive CUSMA deal but will not hesitate to defend its interests, while Washington's new 10-12.5% tariffs on 60 partners take effect today, keeping Monday's 50% levies on roughly $20bn of Canadian goods in sharp focus. With the domestic calendar bare and WTI holding near $91 this morning, the loonie should continue to trade off crude, risk conditions, and trade headlines ahead of next week's Fed decision and May GDP. We still see USDCAD holding near current levels, with rate differentials favouring a medium-term grind lower.