European indices update – FTSE faces inflation and BoE test

Last week, despite softer growth and inflation data in May, the European Central Bank (ECB) raised rates by 25 basis point (bp) to 3.50% and said a further hike in July is "very likely." A surprise upward revision to inflation forecasts and concerns about wage growth has increased the chances that the ECB's deposit rate will reach 4% before year-end.

This week it's the Bank of England's (BoE) turn. The backdrop that the BoE faces contrasts in some ways with the one the ECB met ahead of its meeting. Following a 0.3% contraction in March, UK GDP bounced back in April by 0.2%. The unemployment rate fell to 3.8% in April vs 4% expected. Wages growth, excluding bonuses, increased to 7.2% vs 6.9% expected.

On Wednesday of this week (one day before Thursday's BoE meeting), the BoE will get one final piece of valuable information - the May consumer pice index (CPI) report. The MPC has been granted pre-release access to the CPI report, and it will play a part in Thursday's BoE decision.

The market is looking for headline inflation to rise in May by 8.4% Year-on-Year (YoY) from 8.7% in April and for core inflation to remain stable at 6.8%. Despite expectations that inflation will fall, the market is pricing in a non-negligible 20% chance that the BoE will opt for a 50bp increase when it meets on Thursday. A probability that will most certainly increase if the May CPI report prints hotter than expected. The BoE's terminal rate is viewed at 5.87% by the end of quarter one (Q1) 2024.

The contrast between ECB closing in on its terminal rate and a BoE still with much work to do helps explain why the DAX reached all-time highs this week and the FTSE is still 5% below its all-time highs.

The other reason the FTSE has underperformed the DAX is its high exposure to financial stocks, which have struggled this year globally, and resource stocks which have disappointed due to concerns over China's growth trajectory.

DAX Technical Analysis

In our last update, we noted that the pullback from the mid-May 16,375 high to the recent 15,649 low appeared corrective "Providing the DAX holds above the 15,649 low, we look for a retest and break of short-term resistance at 16,150 with scope to the 16,375 high."

The DAX has since made fresh all-time highs, and dips are likely to be well-supported, leaning against uptrend support 16,000 area.

Aware that should the DAX see a sustained break of 16,000 and then falls below the recent swing low at 15,650ish, a deeper decline is expected towards year-to-date (YTD) lows and the 200-day moving average (MA) of 14,800/600 area.

FTSE Technical Analysis

After breaking below the 200-day MA in early June, the FTSE found and held uptrend support near 7450 (coming from the October 6707 low). While the FTSE remains above uptrend support currently at 7500 and the 200-day MA at 7532, we give the upside the benefit of the doubt.

Aware that should the FTSE see a sustained break of support at 7530/7500 and then falls below the June 1 low of 7445, a deeper decline is expected towards support at 7300/7200, coming from year-to-date lows.