16 August 2021: UK outperforms but concerns remain

UK outperforms but concerns remain

16th August: Highlights

  • Important week ahead for MPC
  • Consumer sentiment falls sharply
  • Draghi effect buoys Italian economy

Employment and inflation data to shape the week for pound

Any Central banker will say that a single dataset will never determine the path of monetary policy, as it is the trend that decides the Bank’s actions.

Therefore, data that is due for the release this week will add to the picture that is being created of inflation and employment, but members of the Bank of England’s Monetary Policy Committee now have fairly clear impressions of both what they expect and where the detail will fit into the monetary policy jigsaw.

Inflation will remain above the Government’s 2% target when data for July is reported on Wednesday, but it will be the trend that determines if a sufficient number of MPC members become convinced that action is needed to bring it under control

Market expectation is for headline inflation to have fallen to 2.2% from 2.5% as supply issues continue to ease. However, producer prices, which will also be released, are expected to stay strong.

Producer prices are a major indicator of future consumer price inflation, as they express the price of raw materials and labour costs at the factory gate.

At best, the data will encourage the more dovish members of the committee that a tapering of the Bank’s support for the economy can be delayed for a further month or two.

The other major piece of data to be released this week is the employment report, also for July, that will be released tomorrow.

The unemployment rate is expected to remain at 4.8% with a fall in the claimant count dropping from June’s 114k to between 80k and 90k.

Concerns remain that the complete removal of the Government’s furlough scheme next month will lead to an increase in unemployment.

Average earnings are still rising sharply, and this will add to inflation concerns.

The summer lull has led to a drop in liquidity; however, the data still has the potential to drive the pound in either direction quite significantly.

Last week, Sterling was heavily influenced by the dollar. Its inability to break through significant support levels and a poor set of data (see below) saw the Greenback retrace most of its recent gains. The pound traded between 1.3894 and 1.3790, closing virtually unchanged at 1.3867.

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Inflation wiping out salary gains

Given that the U.S. economy behaves similarly to an oil tanker when being asked to stop or perform a U-turn, it is clear that management of monetary policy requires a significant amount of forethought and planning.

Add to that the desire of market commentators, analysts, and traders for knowledge of when the ship will stop or when it will start to head in the opposite direction, and the job of the FOMC becomes fairly clear.

Jerome Powell has spent a large part of the second and third quarters fending off questions about changes in monetary policy.

He has been fairly open about the direction of the economy but given the pace at which GDP has recovered, the supply bottlenecks being seen across the country and the number of jobs being created despite continued lay-offs, speculation about when a tapering of monetary policy will begin has remained constant.

As has already been said, the trend of the most significant pieces of data points towards a tightening beginning in the Autumn, but the market is unable to stop itself reacting to single pieces of data whether they are positive of negative for the overall scenario

Such an event occurred on Friday, following the release of the University of Michigan report on consumer sentiment. It fell to 70.2 from 81.2 in July. While it hadn’t been expected to change from the previous month’s number, a fall of such magnitude is unprecedented and points to an anomaly in the data.

Taken at face value, the data points to a significant slowdown in consumer activity which could be attributed to two possible factors.

First, there are rising concerns about the continued failure of the authorities to get the Delta variant of the Covid-19 virus under control. Second, the fact that rising inflation is wiping out any salary gains is concerning consumers.

Following the release of the data, the dollar gave back art of the gains it had made over the past couple of weeks. It fell to a low of 92.47, closing at 92.52. It remains well above support at 92.20, so the overall trend remains intact.

But supply chain issues remain

Although concerns remain about the way the ECB has handled monetary policy changes, the Eurozone economy continues to gain in strength, albeit at a slower rate than could be expected given the level of support that has been provided.

One Eurozone member that has performed far better than could have been expected is Italy.

It may simply be the Draghi effect, that shouldn’t be underestimated, but there has been a significant improvement in productivity that has reacted well to an increase in demand. Supply issues remain, as have been seen right across the region, but Italy is definitely recovering far more quickly than its neighbours.

Both services and manufacturing PMI’s are outperforming supposedly stronger economies, but there is still the spectre of high and rising debt to GDP ratio to contend with, as well as a possible banking crisis.

Supply chain difficulties continue to affect the entire region. This has led to a shrinking of the trade surplus, despite the beneficial effect of a weakening currency.

It is expected that as the recovery continues that this will be a temporary phenomenon, but the ECB’s decision that support should stay in place for longer than is totally necessary will see the currency fall further.

Inflation is diverging across members of the Union, based primarily upon the rate at which their economies are recovering and how significant supply bottlenecks have affected logistics. In France, inflation is around 1.2% and falling, while in Spain it is close to 3%. This is a similar level to Germany, which registered a significant increase in the latest period.

Friday’s data in the U.S. provided a little respite to the euro and allowed it to stay above significant support.

The single currency closed the week at 1.1795, having traded as low as 1.1706 earlier.

Have a great day!
About Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”