Rate Hikes in the Balance

Think Tanks advise caution on Monetary policy

The prospect of an interest rate hike in the U.K. which has been underpinning the pound in recent weeks has receded a little as a pair of influential bodies called for caution.

There is no doubt that the U.K. economy is in a fragile state despite inflation remaining stubbornly high and showing no sign of abating. The prime reason for continued high inflation is the weakness of the pound which causes import prices to to rise. The Item Club which is sponsored by prominent accounting firm EY (formerly Ernst and Young) has said that a rate hike in the U.K. is risking hurting an already fragile economy further.

The British Chambers of Commerce also suggested that the time is not right to raise rates citing weak economic growth and low business investment. The pound is holding up well despite several headwinds, comfortably above the 1.3000 and 0.9000 levels.

In the U.S. Fridays inflation data called into question the rate hike that the market expects to happen in December. Despite headline inflation rising due to the recent Hurricanes that have disrupted oil production, the underlying trend is still weak. Janet Yellen, the Fed chair, has recently decoupled economic data dependency from the path of interest rates as the FOMC tries to be more proactive, several of her colleagues remain unconvinced as there is no clarity in the future path of inflation.

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Contradictory data likely to add to rate confusion

This week sees the release of inflation and employment data in the U.K. Analysts are predicting a 3% headline rate for inflation in September. This will bring major concern to the MPC and their colleagues who produce the Quarterly Inflation Report. Inflation had been predicted to peak at 3% in October. It is far from sure that any single rate hike will provide any support for Sterling since a tightening of monetary policy is already priced in.

It is hard to see a November hike as being the first in a series. The Office for National Statistics has admitted an error in underestimating unit labour costs which rose by 2.4% in the second quarter, far higher than the 1.6% previously reported. The rise in hourly earnings is only a part of this data and these are expected to fall back to 2% in September from 2.1% in August, revealing a widening gap between incomes and prices.

Also released this week is the retail sales data for September. The consumer has been robust in its support of the weakening economy and with the holiday season approaching this data will also been keenly anticipated.

House price data released overnight has shown that prices rose by 1.4% year on year nationally up from 1.1% in August which is encouraging but unlikely to influence the MPC.

Euro lower as political concerns spread

The common currency is set to extend its recent weakness as further political issues drive concern. Following the rise of the right in Germany and Catalonia’s secession referendum, Austria went to the polls at the weekend.

The election of the world’s youngest national leader is a cause for celebration as it ushers in a new generation of politicians. Sebastian Kurz was Foreign Minister at 27 and will become Austrian Prime Minister aged just 31. He has moved the People’s party to the Right and has stood on a ticket in which he plans to be tough on immigration. In keeping with a number of
European countries, Austria needs a coalition to form a Government and Kurz is likely to form an alliance with the Right-Wing Freedom Party who accused Kurz of stealing many their policies.

The continued shift to the right in EU member states will concern Brussels and could lead to a shift in immigration policy although there is no threat to the free movement of EU nationals which was a major issue during Brexit campaigning.

The common currency has been unable to break resistance at 1.1820 and continues to suffer from political concerns despite the brightening picture for the economy.

This week’s events of note

Friday’s U.S. employment data and Brexit will continue to dominate. Expect some comment regarding the Prime Minister’s job in the weekend press. Oh, and it’s Labor Day in the U.S. a week later than published.