Last week’s Bank of England meeting delivered the largest rise in interest rates since 1995, a time before it was operationally independent for the setting of monetary policy. The vote was 8-1 in favour of raising interest rates by 50 basis points, with only Silvana Tenreyro, an external member of the Monetary Policy Committee, voting against that option favouring a smaller 25 basis point option instead. UK official interest rates are now 1.75%, a full percentage point above where they were just before the pandemic. Is the economy in more robust health than it was then? I would suggest no. Is the labour market tighter? On the surface maybe, but that is likely a function of larger economic inactivity, in my opinion.

The BoE (Bank of England) has signalled that it is prepared to sacrifice the economy in order to control inflation. The latest forecast predicts a recession for the UK (beginning towards the end of 2022), whether interest rates are left at the current level or rise further from here. Even with the previous and potential additional rate increases, inflation is set to peak above 13% in Q4, and fall back to target by the end of Q3 2024. Inflation is then set to considerably undershoot target over the course of the following year. Notably though the BoE forecasts that growth will slump by over 2% from its peak based on market interest rate expectations, and by 1.25% if interest rates are left unchanged. Meanwhile, surveys of insolvencies show a sharp increase (37% year-on-year) in the number of companies in severe financial distress.

The pound dropped on that news, and then again at the very end of the week, after strong US data. The risks are to the downside for the pound against the US dollar and euro, given that the economic news continues to worsen. If the BoE remains unconcerned by the economic damage, or rather more concerned by the inflation risks, then the downtrend could persist. Raising interest rates in a worsening economic environment didn’t help in the early 1990s, and neither will it here, in my opinion.

This week sees the provisional Q2 GDP (Gross Domestic Product) figures released. The UK is predicted to shrink by 0.2% quarter-on-quarter according to market consensus, and the risks are likely for a larger fall in output, since the rise in output in May made little or no sense. Also released this week are BRC (British Retail Consortium) retail sales values data for July, and the July RICS (Royal Institution of Chartered Surveyors) house price survey balance. The Halifax July house prices data recorded the first drop in prices since 2021, and the RICS survey could contain more bad news for the UK housing market. None of the newsflow is likely to offer the GBP support, in my view, despite the fact that the markets may continue to build some of the UK interest rate hikes back into the curve in the short term.

The Euroland economy has demonstrated some resilience over the course of the past week. Things didn’t get off to a great start with weaker German retail sales figures for June. But the manufacturing and services PMIs (Purchasing Managers’ Indices) for final-July were revised up, and the June industrial production data from Germany, France and Spain all materially outperformed consensus expectations, compensating for a significant undershoot in the same figures from Italy and Portugal. That prompted resilience from the euro, which gained towards the end of the week in spite of the strong US data.

There was also a sharp increase in Dutch inflation, which reported the EU harmonised measure of consumer prices reaching 11.6% year-on-year in July, up from under 10% in June. Meanwhile, Estonian consumer price inflation rose to just under 23% year-on-year from under 22% in June. So, it looks as if the inflation overshoot generally will continue, even though there are signs that the pressure from some parts of the commodity markets appears to be reducing. A report from the Food and Agriculture Organisation reported an 8.6% drop in prices from June to July.

This week started with the Euroland Sentix investor confidence survey for July. It reported a surprise improvement in confidence, which took the markets a little by surprise. The remainder of the week is filled with final-July consumer prices data from Germany, Spain, France and Portugal, and June industrial production figures from Euroland. I still think the euro is in a better place to recover than the likes of the pound or Japanese yen, versus the dollar, but risk appetite still appears fragile, so I would worry that the euro may still come in for some short term pressure over the next few weeks.

The European Central Bank’s job in September could be made easier if there are signs of an easing in the downtrend regarding economic activity. However, it is too soon to expect a turnaround in the Euroland economy and markets may well treat any improvement in economic variables as an anomaly rather than the beginning of an uptrend. 

The US non-farm payrolls data for July was the big release of last week. The outturn of a net 528,000 new payrolls added was more than double that was expected. The unemployment rate dipped to 3.5%, the lowest it has been since the pandemic began in March 2020. The figures also reported average earnings rate at 5.2% year-on-year, then same as the upwardly revised June figure. However, labour force participation dipped in July, back down to 62.1% from 62.2% in June. The strength of the payrolls data increased monetary tightening expectations in interest rate and FX markets, with US bond yields closing out the week sharply higher and the dollar strengthening against all the majors.

However, there are questions around the strength of payrolls, given that US jobless claims are rising, the Challenger Job Cuts survey reports increased layoffs, and the US media has been increasingly focused on large US multi-nationals making labour force reductions. Is it possible that the labour market will remain as robust, or is the current strength a feature of the past economic rebound coupled with COVID related additional hiring?

Last week also saw some comments from Fed members such as San Francisco Fed President, Mary Daly, and resident Fed ‘hawk’ St Louis President James Bullard. Daly suggested that the inflation being experienced was 50% demand and 50% supply led, but the vast bulk of US inflation is in necessity goods, and driven by global supply shortages, in my view. Moreover, she also suggested that nobody was currently experiencing a recession, but that conveniently ignored the recent earnings and revenue downgrades from big retailers, plus the two consecutive quarters of negative growth recorded by the Bureau of Economic Analysis. Bullard meanwhile continues to push for a further frontloading of interest rate increases, such that US targeted Fed Funds reaches 3.75-4% by the end of the year.

This week’s big releases are consumer price inflation for July and then, at the end of the week, the provisional August University of Michigan consumer sentiment survey. The headline inflation rate might reduce a little in July versus the June outturn, but the core measure, excluding food and energy prices, is expected to rise to 6.1% year-on-year from 5.9%. That rise in headline inflation won’t mean it is at fresh multi decade highs, but the Fed may interpret it as a green light for more aggressive tightening, in my view. Meanwhile, will consumer sentiment recover or continue to plumb new depths? I fear the latter, even though market consensus is for a small improvement. The likely increase in interest rate expectations could offer the USD some additional support, albeit that all major economies are experiencing future rises in interest rates.

Last week began with the Reserve Bank of Australia increasing the cash rate from 1.35% to 1.85% early on Tuesday morning, followed swiftly thereafter by the Banco Central do Brasil hiking the Selic by 50 basis points on Wednesday to 13.75%, replicating the hike in June and suggesting Brazilian interest rates might be reaching a terminal level within the next few meetings. The Reserve Bank of India hiked 50 basis points also, more than consensus expectations but in line with the scale of the June increase. But the Czech central bank stood pat, despite two of the seven members arguing for a 100 basis point hike. At the end of the week, the central bank of Romania raised interest rates 75 basis points but a full percentage point was priced in, suggesting some slowdown in the pace of tightening, one that the Governor had hinted would only occur once signs of a slowdown in inflation had already been seen. There appears to be cracks appearing in the consensus amongst central banks, with some believing that the worst may be over, whilst others are stepping up the tightening to counteract the excess inflation being endured.

For this week, the central banks of Thailand, Mexico and Peru are all due to announce. The Bank of Thailand is likely to hike by 25 basis points to 75 basis points, Banxico are expected to hike a further 75 basis points to 8.5%, replicating the hike in June, and the central bank of Peru is likely to hike by 50 basis points. The central banks in Latin America are likely to be concerned by the step up in Fed tightening seen recently, and the damage that could do to their currency stability. On the flip side though, the risks of a slump in economic activity remain of concern for all authorities, and there are already signs that a slowdown is underway. At some point, that problem with growth will be larger than the problem from inflation, in my opinion, and not just for emerging market central banks either.