14 September 2023: The UK economy shrunk by more than expected in July

It was expected that the economy would have failed to post any growth in July as the poor weather and a series of strikes led the economy to shrink by 0.5%.

Another hike in interest rates also contributed to falling demand and led to fears that the good news that has been seen recently about the UK’s prospects has ended.

It had been predicted that the economy would have shrunk by 0.2%, but construction projects and retailers saw activity fall by significantly more than expected.

The country has been walking a tightrope for several months teetering on the edge of a lowdown which has been averted by a series of one-offs. It is possible that the country is already experiencing a mild recession that has been masked.

A recession, in which the economy contracts for two consecutive quarters cannot be ruled out as economists have already been expecting the economy to flatline between now and the end of the year. If the issues that have provided positives now turn negative, they could easily result in contraction.

The Government fell back on recent good news stories to try to appear confident about the future, but the Opposition called it “another dismal day” for the economy and called for an election to be called sooner rather than later.

Chancellor of the Exchequer, Jeremy Hunt pointed to the fact that the economy is expected to fare better than Germany, Italy, and Spain in the long term.

That will be cold comfort to consumers who are still suffering from high inflation and a cost-of-living crisis that is lingering as the Bank of England is expected to hike interest rates again next week.

Unemployment is beginning to rise according to data that has been released this week and while there was cause to accept that this was due to the general effect of tightening monetary policy, there are fears that it could also be the start of a more serious downturn.

The pound fell to a low of 1.2434 but recovered to close at 1.2490 against the dollar. Versus the Euro, it lost ground initially but recovered to close at 1.1642 which was marginally below the average the average has seen over the past month.

Headline inflation rose as expected, driven by the increase in oil price which quickly fed through into the forecourt price of gasoline, despite demand beginning to slow.

This has led to renewed fears that the FOMC may feel the need to hike interest rates again at its meeting next week, despite all indications being for another pause.

In truth, there have been very few comments from FOMC members lately leading the market to assume that given the data that has been released, particularly around employment that a pause had become likely.

In his most recent speech, Fed Chairman, Jerome Powell had warned that the fall in headline inflation would not be linear and may lead to further hikes “down the road”.

Inflation had been expected to rise to 3.3% or 3.4% but it came in at 3.6%. Since the tightening. It may be that Powell and his colleagues will see this as a one off, but the market is now considering a further tightening of monetary policy at next week’s meeting.

With interest rates already almost restrictive, there is a fear that the effect on the economy could lead demand to fall and job losses to increase which would bring a recession “back to the table”.

There are still fears that several states could see a recession in an equivalent manner to what is happening in the Eurozone.

A threatened strike by members of the United Auto Workers Union would see vehicle production halted. This is an area of the economy that has been performing particularly well lately, fed by people’s patriotic fervour to buy American wherever they can.

A strike would affect 150,000 auto workers and lead to a contraction in the economy. General Motors, Ford, and Stellantis, which owns Chrysler, Jeep and Dodge have so far failed to reach an agreement over the contracts and working conditions and a walk-out now looks likely.

The dollar Index was barely affected by the inflation data although the prospect of a further hike saw it gain marginally.

It rose to a high of 104.98 and closed at 104.77.

The Governing Council of the ECB will meet today to make the long-awaited decision on monetary policy. This meeting is a true definition of being too close to call, with several previously hawkish members of the Council remaining quiet or making modestly dovish comments that have led to the market remaining unsure about what will happen.

The most popular outcomes are for a pause to be announced by ECB President, Christine Lagarde with a warning that rates will need to increase further later in the year if inflation remains “sticky, or a hike accompanied with advance guidance that a pause is next month depending on the data.

There are a number of important players in this drama whose comments are likely to sway the vote but given that voting numbers are kept confidential, the market will need to make assumptions based on the outcome.

The German Central Bank President, Joachim Nagel has barely spoken about monetary policy recently which has led the market to expect him to favour a pause. Klaas Knot the Head of the Dutch Central Bank and Pierre Wuncsche from Belgium have both been more outspoken about a hike in the past. Two Baltic states, Latvia and Estonia who are suffering from exceptionally high rates of inflation are two nations that have recently been outspoken about the need to continue to hike rates.

Italy will, of course, vote to end the cycle of rate hikes given the stand it has taken for several months.

A clash is looming between Italian Prime Minister Giorgia Meloni and Christine Lagarde about Italy’s insistence on introducing a windfall tax on its banks. While individual nations are free to introduce new taxes under EU treaties, banks are considered to come under the auspices of the ECB.

There has already been criticism levelled at Meloni, but she has “stuck to her guns” using tighter monetary policy as her motivation.

The Euro is likely to have a volatile day, no matter the outcome of the meeting. Yesterday, it fell again to a low of 1.0711 and closed at 1.0729.

The support and resistance levels that need to be observed today are around 1.0795 and 1.0660.

Have a great day!