17 August 2023: Headline inflation falls to 6.8%


  • Inflation slows, but recession risk remains
  • Exporters suffering from strong dollar
  • Industrial output surges
GBP – Market Commentary

Core inflation unchanged

Good news about inflation has been in short supply for quite some time, but yesterday the Government and Bank of England will have been buoyed by the news that headline price increases fell by more than one percent in July.

While the data had been expected to show a significant improvement, the news was nonetheless gratefully received.

Headline inflation that had been at 7.9% in June, came in at 6.8%, while the core, which has the more volatile items like food and energy stripped out, was unchanged at 6.9%.

Despite inflation seeing a considerable improvement, it is still far too high for the Bank of England’s liking and a further hike in short term interest rates is expected to be agreed at the next meeting of the MPC which takes place on September 21st.

The fall in inflation brought the headline to its lowest level since February 2022 and was due to falls in energy prices. The wholesale price of gas has been falling continuously since it made a record high last August, so the fall in inflation had been expected.

Producer Prices, which record prices at the “factory gate” and are used to measure consumer price inflation in the future, also fell from 3.1% in June to 2.3% last month. This is more likely to affect the Bank of England’s ongoing decisions on interest rates since it shows that the trend for inflation is likely to continue.

However, wholesale prices for foodstuffs and energy have risen marginally over the past six to eight weeks, so the data for August is unlikely to show such a significant fall and may see another rise.

Economists at several major accounting firms agree that a recession in the early part of 2024 is still possible if the Bank of England perseveres much longer in its policy of rate hikes.

With rates now restricting demand, speculation about when the MPC will see fit to halt the cycle of hikes continues.

With inflation still well above the Government’s 2% target, and likely to remain so for at least the rest of 2023, rate hikes may continue well into the Autumn.

The pound rallied to a high of 1.2766 following the release of the data but a dollar strength later in the day saw it fall back to close at 1.2731.

USD – Market Commentary

A recession remains unlikely, but…

Data was published which showed a marked improvement in the construction market last month. After falling for several months both building permits and housing starts rose in July.

This is encouraging news for those economists who feel that the Fed has engineered a soft landing for the economy, even if that was more by luck than judgement.

It is obvious that Jerome Powell and his colleagues on the FOMC did not set out to drive the economy into a recession and their actions around the turn of the year bordered on the alarming, but Powell while hoping for a soft landing, which is virtually impossible to manufacture given the number of imponderables that drive growth, was prepared to endure a mild recession if it brought inflation back close to the 2% target.

The minutes of the latest FOMC meeting were published yesterday and while they hinted at an end to rate hikes there remained a note of caution regarding future inflation which showed that the FOMC will not shirk its responsibility for the sake of a soft landing.

The minutes showed that members of the committee noted “upside inflation risks” returning later in the year, which may lead to further rate hikes “in the pipeline.

Market perception remains that a further pause will be agreed next month since “some” members remain concerned about the resilience of the economy. They felt that the data may be painting an unduly optimistic picture while regionally, they are not as confident in the recovery.

Below trend GDP growth and the beginning of a softening of the employment market led the committee to remain vigilant about how strong the economy will be if rates continue to rise.

The possibility of further rate hikes was enough to drive the dollar index to challenge resistance at 103.55. A thin August market did not have the momentum to drive it higher, and it fell back to close at 103.44

EUR – Market Commentary

Divestment will be necessary once rates hikes are halted

When the “holiday month” is over, ECB officials will have enough on their plates with a potential watershed decision to make on interest rates as well as consideration of the slowdown in economic activity recently. However, there are two further issues that appear to have been avoided and will need to be addressed.

The first is the considerable and growing level of bad and doubtful assets that remain on the region’s banks’ balance sheets and the reduction on the ECB’s own balance sheet.

The saga of the bad and doubtful loans has been ongoing for a long time and stretches back almost ten years.

The regulator gave banks a significant grace period in order to allow them to rebuild their balance sheets which were badly affected by the 20098 and 2012 financial crisis, but the issue remains an “elephant in the room” and needs to be addressed if the European Union is to grow into the global force to challenge the U.S. and China.

America is very aware of the role of the regulator in the health of its banks and would consider any considerations which “paint outside the lines” of recognized accounting practices to set a dangerous precedent.

There is also the significant overhang of bond purchases that the Central Bank made during the Sovereign Debt Crisis to consider. It feels like the ECB has simply been paying lip service to the need for the size of its balance sheet which has become bloated and has cost it billions in mark-to-market losses as rates have risen.

The European Commission, which tends to leave the ECN to its own devices, has been “making noises” recently about its concerns over the lack of action that is taking place.

There was better news on the economic front yesterday with the release of industrial production data. Month-on-Month, output rose from being flat in June to a rise of 0.5% in July. This led the year-on-year figures to improve from -2.5\ to -1.2%. While the numbers are nothing to write home about, even the longest journey starts with a single step.

The euro suffered as the FOMC minutes predicted that the Fed would remain in lockstep with the ECB on rate hikes. It fell to a low of 1.0871 and closed at 1.0871 as the important 1,10 level disappears further into the distance.

Have a great day!

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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.