1 September 2023: Another rate hike is becoming more likely

Huw Pill, the Chief Economist at the Bank of England spoke yesterday of the determination of the Bank to “see through to the end” its fight against inflation.

Many observers took that as a hint that there will be another twenty-five-basis point hike in interest rates when the MPC meets again in three weeks’ time.

Pill went on to say he and his colleagues are aware of the unnecessary damage that could be inflicted on the economy if rates are raised too much, but the Bank feels it must concentrate primarily on tackling inflation. Interest rates are likely to stay elevated for some time.

Inflation fell to 6.8% in July and while it can be considered to be moving in the right direction, the base rate needs to be at a level where it is restricting demand, but not severely affecting employment and growth unnecessarily.

The most recent employment data shows that there is still capacity since the claimant count is constant, while he feels that the country can avoid a recession in the coming months.

Pill feels that the base rate is already in restrictive territory and there is a danger that rates could be tightened too much but that danger needs to be balanced against bringing inflation back to the Government’s target of 2%

The current forecast is for inflation to fall to around 4.9% by the end of the year, but with rates remaining around their current level there is a degree of confidence that barring any shock it will continue to fall.

Food prices are showing further signs of moderating, but there remain some issues with supply chains and a scarcity of some basic items due to the continued conflict in Ukraine.

Concerns have been raised about the effect of interest rate hikes on the housing market and mortgage rates. Lenders have reacted to a recent fall in long-term interest rates and mortgage rates appear to have peaked and, in some cases, begun to fall.

Warning that there is no room for complacency, Pill said that at every meeting of the MPC there is a “full and frank” exchange of views, and that it is unfair to believe that there is a degree of groupthink among the full-time members of the committee.

The pound ended the month giving back some of its gains from the previous day. It fell to a low of 1.2652 and closed at 1.2673.

Personal Consumption Expenditures (PCE), Jerome Powell’s preferred measure of inflation rose marginally year-on-year from 4.1% to 4.2% last month as consumer spending rose by 0.8%.

This was in line with the Fed’s target for the more commonly used CPI data at 2%. This, coupled with the unexpected downward revision to Q2 GDP, brings into question whether the FOMC will feel the need to hike interest rates at its next meeting.

A lot will depend on the August employment report which is due for release later today and CPI data which is due in a couple of weeks’ time.

As well as watching the headline number of new jobs created, market analysts will want to see what is happening to wage growth and if there is a wage/price spiral developing.

The current estimate is for 170k new jobs to have been created, but there is a larger margin for error this month as the data is being published on the first day of the month which means it will contain more estimates than normal.

Average earnings growth is expected to have fallen from 0.4% in July to 0.3% last month. This will be seen as further evidence that there will be a pause in rate hikes.

The risk for the new jobs created is now to the downside. The market has been expecting a significantly lower number of new jobs to be created for several months and their expectations have been continually dashed, but as interest rates have moved further towards restrictive territory, they come closer to an inflection point.

The main takeaways for the Fed for the PCE were the encouraging that as activity rose, prices for goods remain stable. On the flip side, prices paid for services are still rising.

With the market slowing down ahead of the Labor Day weekend, there could be significant volatility seen later if the employment report is out of line with expectations.

The dollar index recovered some lost ground as the market realized its overreaction to the downwards revision of Q2 GDP. It rose to a high of 103.73 and closed at 103.63.

As members of the ECB’s Governing Council return from their annual holidays, they are facing accusations of “financial vandalism” for the continuous rises in interest rates that they have made in the past year.

There is a growing feeling within the Eurozone that there is an unhealthy fascination with bringing inflation down among some Council members that is damaging the economy as a whole and some individual members more than others.

It had long been assumed that the September meeting of the Governing Council would see at last a pause on rate hikes announced, if not a halt, to allow the economy to catch up with monetary policy changes.

Some of the more hawkish members will point to yesterday’s publication of harmonized inflation data for the entire Eurozone as showing that inflation remains too high and the fact that is falling only marginally shows that interest rates are not yet at a restrictive point.

That view completely ignores the outside influences like the conflict in Ukraine and the energy crisis that have severely affected the Eurozone this year.

The inflation data and the fact that the ECB has seen a pause due to the gap between meetings makes a further rise this month more likely.

It is interesting to note that the commentary on the reasons why a further hike is necessary has been left to the heads of the Latvian and Austrian Central Banks.

The president of the Bundesbank has been conspicuous by his absence. It is likely that given the parlous state of the German economy, due in no small measure to the constant hikes in interest rates, that Joachim Nagel keeps a lower profile.

Harmonized inflation rose by 0.3% in August following a 0.1% fall in July. This contributed to a year-on-year rate of 5.3% down from 5.5% previously. While it is moving in the right direction, inflation is still too high to consider a pause from the ECB to be considered this month.

Going into the final quarter of the year with interest rates likely to still move higher will cause considerable angst among several members of the Eurozone, not least Italy, which blames the ECB for the fact that its economy is teetering on the edge of a recession.

The Euro gave back all its gains from the previous day as the market positioned itself for the release of the employment report in the U.S.

It fell to a low of 1.0835 and closed at 1.0843.

Have a great day!