Inflation expectations have fallen in the Bank of England’s DMP business survey. There was dovish testimony last week from Governor Bailey that a marked fall in inflation is likely this year. Mr Bailey suggested that monetary policy is probably near the top of the cycle, similar to the European Central Bank and Federal Reserve. The BoE is still expected to increase rates on 21st September, but may then pause. With lower rate expectations, UK gilt yields have fallen relative to US Treasury yields and sterling has fallen against the dollar, back below 1.25.
The labour market data was expected to be soft, and unemployment has risen to 4.3% from 4.2%. There was a fall in employment of 207k, which was a touch higher than the 185k expected by markets. However, whilst many expected average earnings to fall, they actually rose from 8% to 8.5%. These wage growth figures are clearly much higher than the BoE’s 2% inflation target, though the DMP survey suggested they would continue to fall over the coming months.
Given the generally softer data, GDP is expected to have fallen in July by 0.3%. Following the surprise 0.5% gain in June, the bad weather is likely to have impacted consumer services and construction. Some areas within services are also likely to have been impacted by strike action, especially in health care and education. Industrial activity is also likely to be lower, given the 1.7% fall in manufacturing output. Given a weaker start to the quarter suggests, we may see slower growth than the BoE’s forecast of 0.4%.
GBPUSD – 1.2498
GBPEUR – 1.1652
The key this week will be the European Central Bank’s policy decision. The ECB has raised rates for the last 9 meetings. However, this decision is on a knife-edge with weaker growth balanced against lingering concerns about high inflation. An ECB consumer survey indicated that CPI expectations remain above the 2% target in 3 years’ time, rising for the first time in four months to 2.4%.
The case for a pause is that the Eurozone growth outlook has weakened, with the latest PMI surveys pointing to a contraction in GDP this quarter. The ECB had predicted GDP growth of 0.9% this year and 1.5% in 2024. These forecasts are likely to be revised down, with consequently lower inflationary pressures. This may bring forecasts to 2% inflation by 2025. In the near term, inflation is likely to be raised due to higher energy prices, which may spread out to broader inflationary pressure given the tight labour market.
The recent activity data paints a gloomy start to this quarter. Factory orders in Germany plunged by 11.7% in July. Industrial production dropped by 0.8% which is the third fall in a row. GDP growth for the Eurozone was also revised lower to 0.1%. Even if the weaker data leads to a pause by the ECB, they are likely to emphasise that rates will need to remain high for longer. President Lagarde’s comments at the press conference will be closely watched to see how the committee view the future path of rates.
EURUSD – 1.0726
EURGBP – 0.8582
Markets have been volatile, with Treasury yields rising with expectations of fewer rate cuts next year than previously priced in. Markets are expecting rates to stay higher for longer globally. The Fed is still likely to pause at their next meeting on 20th September. Given the changes in other central banks’ views and the higher for longer US rate expectations, the US dollar has been broadly stronger over the last week.
Last week, the ISM services survey was unexpectedly strong, increasing to 54.4 in August. The report suggests that services activity was boosted by stronger consumer spending. Weekly initial jobless claims also fell to the lowest level since February, in a further sign of a tight labour market.
This week, key releases include CPI inflation and retail sales. Higher energy prices are likely to drive inflation higher by around 0.6%, which would lift the annual rate to 3.6%. Core CPI is also expected to rise slightly, though this would still see the annual rate fall back to 4.5%. Retail sales is expected to remain strong given other consumer spending data. A further rise of 0.4% is forecast, which will underline the persistent strength of the US economy.
GBPUSD – 1.2498
GBPEUR – 1.1652
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*Interbank rates are correct at 7am on the date of publishing.