United Kingdom: economy under increasing pressure of inflation and interest rate hikes

The release of a number of important UK economy data updates only served to worsen sentiment towards the GBP last week. Firstly, the July figures from the labour market recorded that employment growth was slowing, the number of vacancies had reduced, economic activity had risen further, but also that unemployment was at multi-decade lows and average earnings growth was rising.

Secondly, the consumer price inflation data for August reported a small drop in headline inflation, thanks to a double digit drop in fuel prices which only just compensated for a sharp rise in food price inflation. Meanwhile the core CPI (Consumer Price Index) rate rose to 6.3% year-on-year, its highest reading since March 1992, which will have likely worried officials at the Bank of England. The final release of the week, retail sales volumes for August was quite simply dreadful. Volumes fell 1.6% month-on-month, with all categories of retailers suffering a sharp reduction in volumes. The bite of inflation appears to be getting larger regarding discretionary spending, with internet retail and department stores suffering the largest falls.

Interest rate expectations increased last week, with the markets re-pricing for a peak in UK official rates of over 4.5%. Despite the weakening in the official activity data. However, it appears that the FX markets are pessimistic about not only the UK’s economic prospects, but also the remedy proposed by the Bank of England to tackle inflation. The pound fell to fresh multi-decade lows against the US dollar, at one point on Friday reached close to $1.1350 (coinciding with the 30th anniversary of Black Wednesday and the pound’s ignominious exit from the Exchange Rate Mechanism). Meanwhile against the euro, the pound traded as low as €1.14, and it also underperformed against the Japanese yen as well.

It is difficult to see how this week’s data and events will alter the market sentiment about the UK or the GBP. The markets were closed on Monday for the Queen’s funeral, and over the remainder of the week the key events / releases include the Bank of England Monetary Policy Committee meeting on Thursday, and September consumer confidence and PMI (Purchasing Managers’ Index) indices released on Friday. Even though there might be a surprise or two in store from these events and releases, I think it would require something seismic to alter opinions in financial markets.

GBPUSD risks lie towards $1.10 and in GBPEUR towards €1.1250, in my view, even though the news from the US and Euroland is unlikely to be upbeat either. I wonder what will have to change to turn sentiment around in financial markets. Perhaps the answer may lie elsewhere instead of in domestic UK data releases and events?

Europe: inflation continues to deteriorate along with the economy

Last week, the August Euroland consumer price inflation figures confirmed that the overshoot versus target had continued to increase, but also the Euroland industrial production figures reported a much sharper than expected deterioration in output in July. The German ZEW* survey for September reported worse than forecast outturns for both the current situation and expectations indices, another signal of the troubles besetting what was once the industrial powerhouse of Europe.

This week has gotten off to a bad start. German producer price inflation figures reported an eye-watering 45.8% year-on-year increase in August, far higher than market consensus forecasts had anticipated. There was also a surprise increase in Finnish unemployment in August, and July Euroland current account figures reported the highest deficit since November 2008 at the height of the global financial crisis. Over the remainder of the week, there are a plethora of surveys from Euroland and its major constituent countries that are likely to paint a pretty bleak picture of the economic situation for now and into the remainder of this year, and the beginning of 2023.

The euro has staged a comeback against the US dollar, but the rally seen so far has been unimpressive in my view. If the economic data and survey continue to worsen from here, it is difficult to see how the euro will be able to sustain any upward momentum versus the US dollar, in my view. I still think new lows will be tested in the coming few weeks for EURUSD, with the worst of the economic news yet to be seen.

*Zentrum für Europäische Wirtschaftsforschung / Germany’s Sentiment Index

United States: will the Fed hike 75 or 100 basis points this week? There are dangers to doing either

The US markets last week saw further signals of the damage being done to the US economy. Mortgage applications continue to decline, industrial production fell unexpectedly in August, and retail sales values failed to recoup July’s losses in the August outturn. Even with the news from the US economy reporting a general decline in levels of activity, the Federal Reserve continues to concentrate on the inflation problem. This was also highlighted in August figures released last week, with the headline consumer price inflation rate only dropping back to 8.3% year-on-year and the core CPI jumped to 6.3% year-on-year from 5.9% in July.

The jump in core inflation is clearly worrying the Fed, even though it remains prompted by the indirect effects of increases in necessity goods and services prices, which in turn is driven by the ongoing supply side issues. When the Fed meets this week to decide on monetary policy, there are some individuals that will push for a 100 basis point increase in the targeted Fed funds rate. However, hopefully common sense will prevail, as such a move would smack of panic and also likely prompt markets to price in an even higher terminal rate for US official interest rates.

This week has already seen more evidence of the rapidly worsening conditions in the US housing market, with the September NAHB (National Association of Home Builders) housing market index dipping to 46 in September, its lowest level since May 2020, and outside of the pandemic, an 8 year low. Latest weekly MBA (Mortgage Bankers Association) mortgage applications data and August existing home sales figures are released ahead of the Fed decision, and then the provisional September PMI indices for manufacturing and services on Friday. For the US dollar, any overly aggressive moves by the Fed could backfire as far as the macroeconomy is concerned, without providing the benefit in terms of breaking the back of inflationary pressures, in my view.

Central banks: Russia cuts again last week as sanctions bite; Sweden already surprises with a hike this week

The only notable central bank decision of last week was from the Russian central bank, that cut the key rate to 7.5% from 8% in line with consensus forecasts. The cut in Russian interest rates was hardly a surprise given the weakness of the economy, and an announcement on Tuesday of this week, for votes to be held on whether the disputed regions of Donetsk and Luhansk should become Russian territory between 23 and 27 September could bring about a fresh round of sanctions from the West on Russia, intensifying the negative pressure on Russian output.

This week, we’ve already seen the Swedish Riksbank hiking interest rates by 1 percentage point to 1.75%, when only a 75 basis point hike had been expected. The Riksbank has renewed its commitment to fighting inflation, albeit this is inflation the Swedish economy isn’t entirely responsible for creating. Yet Swedish GDP (Gross Domestic Product) is around 5% higher than it was prior to the pandemic, but take away that increase in GDP and prices would still be well above the Riksbank target, in my view.

For the remainder of this week, the markets will look ahead to the central bank meetings in Brazil, Switzerland, Norway, Japan, Taiwan, Indonesia, South Africa, Turkey and the Philippines. Only Japan and Turkey are expected to hold interest rates steady, with the rest of the central bank decisions just being about the scale of the tightening. A number of emerging market central banks, that are set to announce after the Federal Reserve, will likely wait to see what the US do, and then follow suit. This could be a week of bumper rate increases, and that despite the damage it will do to global economic activity, in my view.

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