The outlook for the UK economy has been steadily worsening, but some of last week’s activity data offered unexpected positivity. This was in the form of the Q3 GDP (Gross Domestic Product) estimate, which recorded a contraction in output of 0.2% quarter-on-quarter, much less than the 0.5% consensus forecast. However, the news wasn’t particularly positive for several reasons. Firstly, much of the positive momentum came from government spending, net trade and investment spending, areas that could all be negatively affected by the prospect of a weaker pound, more interest rate increases and higher taxes. Secondly, the weakness in the economy at the end of the quarter was worse than expected with monthly GDP contracting by 0.6% month-on-month, services output down 0.8% month-on-month and both industrial production and construction output posting surprise improvements - without which the UK GDP outturn would have been worse in September. Thirdly, the GDP figures papered over some significantly worse news from the housing market, with the RICS (Royal Institution of Chartered Surveyors) housing survey point to a drop in house prices in October.

This week there are plenty of releases to focus on, with the labour market data for September and October on Tuesday, followed by Wednesday’s October consumer, retail and producer prices release, and then Friday’s releases of the November GfK (Growth from Knowledge) consumer confidence and October retail sales volumes. The figures from the UK economy might present a mixed picture with higher inflation readings, but weaker activity. There might be a modest improvement in retail sales and consumer confidence, but both would be from very low levels.

However, all of this is likely to play second fiddle to the Chancellor’s fiscal statement due on Thursday. The Chancellor has warned that taxes and spending will have to adjust to fill the shortfall in the public finances, but with economic conditions deteriorating could this backfire? Tighter monetary and fiscal conditions could add to the UK’s woes, prompting a deeper recession than previously expected. It certainly goes against the basic construct of Keynesian economics. The markets may receive the Chancellor’s announcements badly, which may reverse some of the recent rebound in GBPUSD. The GBP may struggle for additional momentum higher from here, in my view.

The US releases from last week were telling. Not only did headline consumer price inflation slip back in October to its lowest level since January 2022, but there was a further dip in mortgage applications, an unexpected rise in jobless claims, and the University of Michigan consumer sentiment figures recorded a sharp drop in the preliminary November release. There are ongoing signs that the US economy is suffering a renewed downshift in activity, albeit that this has thus far been insufficient to give the Federal Reserve enough comfort to argue for limiting the extent of further hikes in interest rates.

Comments from Fed Governor Christopher Waller highlighted this over the weekend. Whilst there was a strong hint that the Fed would perhaps slow down the pace of tightening, opting for a 50 basis point rise at the December meeting, there was a warning also. Waller indicated that the current level of interest rates, and indeed where the terminal rate was predicted to be, might be insufficient to get inflation back under control. 

The Federal Reserve needs to be very careful about the next moves in interest rates from here. The US housing market is already in recession, and this week’s data and survey evidence is likely to point to a further worsening in conditions. Moreover, headline strength in retail sales values figures for October is expected, but volumes remain under pressure along with household budgets. Finally, the October leading index, which has reported a sharp deterioration in economic conditions in the past nine months is expected to report a further worsening in its latest reading. 

As for the US dollar, it has continued to back away from recent highs, with the sell-off gaining additional momentum post last week’s CPI (Consumer Price Index) report. The risks are for a further sell-off albeit FX markets should heed Fed Governor Waller’s words regarding monetary tightening. The Fed remains likely to hike to a far higher interest rate peak than the Bank of England or European Central Bank, in my view.

Last week saw relatively few important releases from the Euroland economy, although there were better-than-expected figures from German industrial production and the Euroland Sentix investor confidence index for September and November respectively. There was also an upside surprise from the Italian and Euroland retail sales figures for September. However, the focus was on the European Commission Autumn forecasts which were released towards the end of the week. The European Commission revised down the 2023 growth forecast from 1.4% in the summer forecast to just 0.3%, and predicted the economy would recover, but only by 1.5% in 2024. Inflation was also expected to peak higher and average higher in 2022 and 2023 than in the summer forecast. Even with these downgrades, the risks are likely to the downside in terms of economic activity for the coming 18 months to two years, in my view, with the German economy only expected to endure a brief and shallow recession.

This week, the key release is the German ZEW* survey on Tuesday. Will this enjoy a significant improvement in the current situation and expectations indices? I would suspect so, but given the underlying weaknesses of the German economy, nothing is certain. Already out this week have been better-than-expected Euroland industrial production figures. Whether the positive news is sustained throughout the winter is more questionable, with possible energy constraints and a weakening in global economic conditions putting downside risks to output outturns, in my opinion.

As for the EUR, the recovery against the USD has continued, but the currency has made little progress elsewhere versus the likes of GBP and JPY. A worsening economic outlook is unhelpful to the EUR if it is worse than the performance expected from the likes of the UK and US. That appears to be the case at the moment, so there are questions about how much further the EUR can appreciate. Against the GBP it may get some help from this week’s UK fiscal statement, which may materially weaken the UK’s outlook, in my view.

 * Zentrum für Europäische Wirtschaftsforschung / Germany’s Sentiment Index

Last week saw the Romanian central bank only hike 50 basis points when it was expected to hike by slightly more. The National Bank of Poland left policy on hold, when it was expected to raise rates a further 25 basis points to 7%. Does this suggest that monetary policy has almost reached its peak in Eastern Europe? Perhaps, but it is not a model being followed by the central banks of Latin America. Banxico raised the Mexican official interest rate to 10% at its latest meeting, whilst the central bank of Peru raised interest rates to 7.25%, a 25 basis point hike. The central banks are still struggling with high inflation and weak currencies, and even though the US dollar has had a setback recently, the cumulative impact on inflation remains of concern to monetary authorities in Latin America, in my opinion.

This week sees the BSP (Central Bank of the Philippines) and BI (Central Bank of Indonesia) in focus. Both are expected to hike interest rates, albeit the BSP is expected to hike by 75 basis points whilst BI is only forecast to hike by 50 basis points. The question though will be more around the outlook for growth and inflation in these two economies, given the worsening regional and global economic outlooks. At what point does this count more than the recent surge in inflation or weakness in the currencies? If there are some signals from either central bank that there is a growing concern over the outlook for output, then that could put a cap on the scale of future interest rate hikes, in my view. Recent moves lower in the PSP and the IDR, which happened post the US CPI release, may also prove helpful in respect to additional monetary tightening.