20 August 2026: Fears grow over a likely interest rate hike

Following the recent reset of the energy price cap, consumer price inflation rose to 2.9% in the year to July, up from 2.6% in June, according to data the Office for National Statistics published yesterday. Services inflation, closely watched by Bank of England policymakers as a signal of wage pressures, eased to 3.4%, while core inflation, which strips out food and energy, remained at 2.6%.

“Upward pressures included furniture prices falling by less than usual for this time of year, and a smaller fall in clothing prices due to reduced discounting,” Mike Hardie, deputy director for prices at the ONS, said.

“The prices of materials and goods leaving factories slowed again, driven by a drop in crude oil and refined petroleum, which led to lower transport costs.”

Chancellor John Healey has said “Britain’s economy is resilient” despite the war in Iran affecting “prices here at home”.

He backed Government cost-of-living measures to ease pressure on families. “We have cut VAT on electricity bills and capped bus fares at £2, to give breathing space to those feeling the strain,” Healey commented. “There is more to do to restore hope and build a stronger economy where prosperity is shared more fairly across Britain.”

Shadow Chancellor Sir Mel Stride said: “Price rises are accelerating once again under Labour. When the Conservatives left office, inflation was bang on the two percent target; now it has been above that level for 22 months in a row. This will worry families across the country. Labour’s tax rises and business bashing have driven the cost of living higher and higher, yet Andy Burnham refuses to rule out yet more tax hikes at the Budget.”

City economists widely believe that inflation is set to peak later this year or in early 2027, at a minimum of about three percent. The delay will come as the effects of volatile energy prices steadily pass through to UK households.

The data will add momentum to the three dissenters on the Bank of England’s Monetary Policy Committee to raise rates at its next meeting, in the middle of next month.

John Healey will have to plug a black hole of up to £11bn in his maiden Budget if Donald Trump escalates his war in Iran, economists have warned.

Economists have agreed that a major energy price shock would push up inflation and wipe out the Chancellor’s breathing space to balance the books.

In a worst-case scenario based on the Office for Budget Responsibility’s (OBR) modelling, the Chancellor would face a £35bn hit if he failed to scale back public spending plans amid intensifying conflict.

This would more than wipe out the £24bn of headroom left by Mr Healey’s predecessor, Rachel Reeves.

The bank said the blow would stem from surging inflation, with its forecasts based on an extreme scenario in which oil surges past $150 a barrel.

This would not only drive up fuel bills but also weaken spending plans across Whitehall. Healey is already committed to a significant rise in defence spending, which will mean cuts in other Government departments.

Sterling rose sharply against the US dollar, driven mainly by a drop in long-dated US Treasury yields, which weakened the USD and pushed GBP/USD to a fresh August high.

Despite the USD-driven lift, sterling fell against the Euro, NZD, and CHF—expectations of continued ECB tightening supported euro strength.

This divergence shows that yesterday was not a broad GBP rally; it was a USD story.

The Federal Open Market Committee held the Federal Funds rate within a target range of 3.50% to 3.75% at its July meeting, with three dissenters calling for a 25-basis-point rate increase. The minutes reinforce that the Fed’s communication strategy has shifted under new Chair Kevin Warsh.

The Committee, driven by its Chairman, is intent on reducing explicit forward guidance and placing greater weight on realised data, while still emphasising that inflation remains above target and that price stability remains non-negotiable.

On inflation, participants continued to view upside risks as significant. Supply shocks, including energy-related pressures tied to the Middle East conflict, were seen as a risk to the return to 2%, leaving officials unwilling to treat the inflation shock as temporary or fully contained.

The minutes show the meeting should not be perceived as a one-sided case for imminent tightening. Participants still saw growth as solid and the labour market as broadly balanced, but also acknowledged elevated uncertainty and downside risks to activity, giving the majority reason to wait for more confirmation before raising rates.

As confirmed at the time of the meeting, three members, Beth Hammack, Neel Kashkari, and Lorie Logan, dissented from the majority, preferring a 25-basis-point hike because they judged that still-elevated inflation and upside risks to the inflation outlook warranted an immediate increase.

The FOMC does not feel it needs to be pre-emptive if and when it raises interest rates, since the data is building a steady case for a hike, possibly as soon as next month.

A professor who has spent years studying financial crises believes the US economy is on the verge of trouble.

Tuomas Malinen, an economist specialising in geopolitics and financial crises, is painting a grim picture for the US. In a social media post this week, the Finnish professor said he analysed several key barometers across financial markets and the broader economy. The findings supported the view that the US is precariously close to another downturn, despite booming stocks and strong surface-level growth.

There is no concrete timeline for when a recession could start, but one of several catalysts could tip the economy into a downturn.

"We need to acknowledge that the bottom can fall out from under the US economy, in practice, at any minute.”

Corporate bankruptcies remain well below their peaks in the years following the Financial Crisis and the dot-com crash, but have climbed significantly since their post-COVID low. In the 12 months to June, the US recorded more than 600,000 new bankruptcy filings, up 12% YoY, according to the US Courts office. It also marks the highest number of new bankruptcies the US has seen since the pandemic.

Corporate bond spreads are also flashing a potential warning for the US, Malinen said. He pointed in particular to the private sector yield curve, which he measured as the spread between BAA-rated corporate bonds with maturities of at least 20 years and the bank prime rate, the interest rate that banks charge their most creditworthy institutional clients.

The private-sector yield curve is close to inverting, which means corporate yields are close to surpassing the bank prime rate. This has only happened in the run-up to a recession.

The dollar weakened broadly yesterday, driven by softer U.S. data, position-squaring, and spillover from JPY intervention. Across G10, USD finished the day lower against 9 of 10 peers, making it the worst-performing major currency.

In a speech yesterday, Christine Lagarde told her audience that the European growth model of recent decades, driven by globalisation, cheap energy and a stable world order, "is eroding". Thus, according to the ECB President, the European growth rate is unlikely to return to what it was before.

For this reason, Lagarde has emphasised the need not to miss the revolution that artificial intelligence represents and believes that, to achieve this, it will be necessary to reduce fragmentation in the European market to allow more investment and help companies gain scale to compete.

Europe was largely left out of the first digital revolution, as other parts of the world disproportionately captured the commercial benefits of the spread of information and communication technologies, Lagarde recalled at a World Economic Forum event. "We cannot afford to repeat this experience with AI, the second digital revolution," Lagarde warned.

The ECB President said Europe has significant strengths, including the world's largest network of trade agreements, first-class manufacturing capabilities, and a highly qualified workforce. For Lagarde, "the challenge is to turn this internal resilience into a source of more durable long-term growth", which requires better leveraging the scale of the European internal market, allowing companies to grow across the EU. "Scale is particularly important," she argued.

"The question is whether Europe can create the conditions for this investment to spread and grow."

For the President, the two main obstacles are the fragmentation of the single market, in which companies still compete too much within national borders, weakening the pressure to adopt new technologies, and the fragmentation of capital markets, which can incentivise young, innovative companies to move outside the EU.

These two barriers reinforce each other, she believes: fragmented markets reduce the profitability of growth in Europe, while fragmented financing hinders expansion, resulting in "fewer companies reaching a global dimension" and slower diffusion of new technologies in the economy.

Philip Lane has been busy since returning from holiday late last week. In a speech yesterday, he said food inflation will be a key driver of overall inflation into next year.

This comes as oil prices are rising again, with Brent crude trading above $90 a barrel, as efforts to end the US war with Iran fall flat.

Lane said inflation depends on energy prices, including both oil and gas, and that energy costs also affect the production of several agricultural products.

“It really is an uncertain situation, but inflation will hover at 3% for the rest of the year.”

Speaking on RTÉ's Morning Ireland, Lane said: "It is not like the 10% we had in 2022, but 3% is still well above the 2% target that we have."

He said food inflation across Europe is relatively low at the moment.

"There have been big food price increases over the last several years.

"Weather events, like El Niño, predictably will lead to more pressure on inflation. In fact, our calculations say this is mostly going to be into 2027," he said.

The Euro strengthened modestly yesterday, supported mainly by broad USD weakness and expectations of further ECB tightening. It reached 1.1680, its highest level in three months, as the USD weakened after U.S. Treasury buyback plans pushed long-term yields lower.

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