Economic Update

Iran conflict intensifies, markets respond predictably

Iran has launched a new offensive against Israel, in retaliation for further Israeli strikes on Hezbollah targets in Beirut. A spokesperson stated that the missile strikes would mark the beginning of a “week of continuous strikes”. Israel has responded with retaliatory action, despite Donald Trump urging restraint.

Markets have reacted in a broadly predictable manner. Oil and gas prices have moved higher, the USD has strengthened, and yields have risen across major economies. Equity prices have declined following the escalation and counterstrike, suggesting that confidence in a near-term de-escalation has deteriorated.

Risks remain skewed towards further USD strength, with GBPUSD and EURUSD potentially moving lower, while USDJPY and USDCAD move higher. Yields may also continue to rise, driven both by the extension of the conflict and its implications for global macroeconomic conditions.

US inflation data in focus after payrolls strength

Following a stronger-than-expected US May employment report, which showed a significant increase in payrolls, attention turns to CPI and PPI releases for May. The labor market data has increased pressure on the Federal Reserve to tighten policy further, and the inflation data may add to that pressure.

Recent data has shown rising energy prices, while core inflation signals have remained more contained. The May releases may provide further clarity, particularly if businesses begin to pass on higher input costs.

If CPI (Tuesday) and PPI (Wednesday) show rising inflation and an acceleration in core measures, this would leave the Federal Reserve in a more challenging position than prior to the releases. USD support may build further in that scenario, although geopolitical developments are likely to remain the dominant driver.

USDCAD approaches 2026 highs despite labor data

Canada’s latest employment report showed significantly stronger-than-expected headline figures. Employment rose by almost 88k, with full-time employment increasing by over 150k. The unemployment rate declined to 6.6% from 6.9%.

However, other components were weaker. Average earnings growth slowed to 3.2% year-on-year from 4.8%, while the participation rate remained unchanged at 65%. FX markets largely discounted the headline strength, with CAD weakening further against the USD towards the end of last week.

Focus now shifts to the Bank of Canada meeting on Wednesday. Markets do not expect a change in policy rates, but the accompanying statement will be closely assessed. A wait-and-see stance remains the base case, although that position may become more difficult to maintain if inflation risks intensify.

USDCAD may test fresh 2026 highs, approaching the C$1.40 level in the near term.

ECB decision in focus, emphasis on guidance

The ECB meets on Thursday to set monetary policy. Markets and economists are aligned in expecting a 25 basis point rate increase, and there is little in current conditions to challenge that view. Risks to the Euro Area economy remain well documented, with higher imported energy costs contributing to elevated CPI inflation and a rise in inflation expectations beyond the central bank’s target tolerance.

If the ECB intends to address sustained pressure from headline and core inflation, the required policy adjustment may exceed the 50–60 basis points currently priced by markets. The press conference following the decision may provide greater clarity on the Governing Council’s assessment and could offer some support to the EUR, allowing it to hold up relatively better against USD strength than other major currencies.

The broader question remains how the balance between growth and inflation evolves. Persistently high inflation could place meaningful pressure on household finances and contribute to stagnation across parts of the Euro Area. The ECB has already indicated that it does not control all aspects of macroeconomic stability.

This raises the prospect that governments may face pressure to increase spending or implement tax measures to support growth, particularly in the context of ongoing geopolitical risks linked to the Middle East.

UK politics and data present a mixed backdrop

Latest polling in Makerfield suggests Andy Burnham remains on course to win the by-election, despite a deterioration in Labour’s national polling position. The contest remains primarily between Labour and Reform, with Labour maintaining a clear lead.

Risks to Burnham’s campaign remain. His previous roles under Blair and Brown may attract renewed scrutiny, alongside his positions on the EU, migration, fiscal policy and net zero. There is also uncertainty around whether further political developments could emerge ahead of the 18 June vote. Polling sample sizes in the constituency remain small, increasing the margin of error. However, the absence of other significant challengers provides some support to Labour’s position.

On the economic side, April activity data is due later this week. March data proved robust and Q1 growth surprised to the upside, raising questions around potential seasonal adjustment effects.

Attention will turn to whether the services sector has maintained momentum. April retail sales were notably weak, and recent PMI data has signaled softening services activity. Risks remain that the data disappoints consensus expectations, which could place downward pressure on GBP.