20 September 2023: OECD sees weakening UK economy


  • UK economy stuck in the slow lane
  • Strikes could be just what the economy needs
  • ECB will be unable to afford to cut rates next year
GBP – Market Commentary

More rate hikes will contribute to continuing weakness

After a summer when the economy was felt to be improving it looks likely that it was another false dawn and the feeling that things would get worse before they got better was, in fact, correct.

The Organization for Economic Development and Cooperation (OECD) downgraded its forecast for GDP in 2024 from 1% to 0.8%, with inflation thought to be higher than previously reported and activity slowing alarmingly.

The report echoed the thoughts of Nouriel Roubini twenty-four hours earlier where he expressed a concern that the country was headed for a period of stagflation, where the economy continues to falter due in no small part to the continued raising of interest rates to combat inflation which continues to defy the Bank of England’s actions.

Roubini went on to say that inflation is now becoming ingrained in the major economies of the world after a period where it was sufficiently benign to allow G7 Central Banks to lower interest rates to historic lows.

Following the Pandemic and the Russian invasion of Ukraine, the outlook for the global economy has completely changed, and it may be as well if the BoE, FOMC and ECB raised their targets for inflation, currently set at 2%, since there is no chance of them being met.

UK inflation is now expected to average 7.2% in 2024, up from the OECD’s previous estimate of 6.9%. This will encourage workers to demand wage increases of at least 7.5% simply to keep pace.

The only glimmer of hope for the country was in the prediction that in 2024 inflation is expected to average 3%, but that will be due to economic conditions rather than the actions of the Central Bank.

The Bank of England convenes the latest meeting of the Monetary Policy Committee today, with the outcome of the vote on any change to be announced tomorrow lunchtime. The five permanent and four independent members are expected to agree to a further twenty-five-point hike, but the view of the market is that rates, already at 5.25%, are close to reaching their peak.

The pound is currently driven more by the expected level of growth than interest rates, since G7 rates are all considered to be close to their peak. Sterling has found a base around 1.2370, but there is little interest to initiate any new long positions ahead of this week’s Central Bank meetings. It reached a high of 1.2425 yesterday but fell back to close at 1.2392.

USD – Market Commentary

Future direction of rates could be as important as the decision later today

Over the past few months Central Bank monetary policy meetings have garnered a greater degree of interest from the market interest rates in most developed economies have reached a neutral level where they are neither accommodative nor restrictive to demand.

The FOMC, which began its two-day meeting yesterday and will announce its decision early this evening, is the only one of the G7 Central Banks that can even claim that it has been driven by the data, since it has already paused its cycle of interest rates once, in June, and may be on the cusp of doing so again.

Although the Fed Chairman, Jerome Powell remain hawkish about the need to continue to tighten monetary policy to achieve a victory in the war against inflation, it has been an uphill struggle to convince several of his colleagues who are driven by a regional view, and see activity in their own areas of the country beginning to ease.

The current continued rise in the price of oil seeing it now comfortably above $90 a barrel is an issue that is beyond the purview of the Federal Reserve, but it will add to the costs of shipping freight around the country which will in turn influence secondary inflation.

The headline rate of inflation rose by more than expected last month and although the FOMC can isolate fuel as being a single cost to consider if the raise in the price of oil remains high it will slowly seep into the economy and drive core inflation higher.

The ebb and flow of economic cycles which drive monetary policy can often be relied upon to cause inflation to peak and trough as jobs go from plentiful to scarce and back again.

The employment market has remained unusually strong over the past year despite the almost constant tightening of monetary policy and economists have been searching for a catalyst to drive job creation lower.

There is a growing belief that a proposed strike by the UAW will cause sufficient turbulence in the economy to facilitate a slowdown which would suit Jerome Powell, although he would never admit it.

The dollar index is currently taking a breather after weeks of renewed strength. Yesterday, it hovered around the 105 level, making a high of 105.20 and closed at 105.15.

EUR – Market Commentary

Villeroy’s comments lead to sharply higher long-term rates

French Central Bank Governor Francois Villeroy de Galhau has gained a reputation as a moderate but deep thinker about the plight of the Eurozone economy and the role of the ECB in it.

For this reason the market takes notice of his speeches and when he comments, as he did earlier this week, that interest rates are likely to remain elevated for some considerable time and the market cannot expect to see any rate cuts for a considerable time the market “sits up and takes notice”.

Villeroy de Galhau is a replacement for Christine Lagarde when her term as President of the ECB ends despite the fact that he would be the third Frenchman (or woman) to hold that position.

The President’s job is unlikely to become free for a number of years but a new way of thinking and delivering monetary policy for the entire Union may become necessary.

The market has accepted the decision from the Governing Council following last week’s meeting, but the price action in Euro trading has revealed two things.

The first is that the common currency is no longer gaining support from monetary policy alone and the second is that even though a hike was eventually agreed last week and pause or halt to the cycle of rate increase is close.

It may very well be that the Euro may receive additional support from the fact that the ECB remains more hawkish about inflation than other G7 Central Banks, and it will retain rates at their current level even as the FOMC and BoE begin to trim rates.

The flip side of the is that is the ECB hikes again in October, it will come perilously close to driving the economy into recession which will harm activity and output, although it will also be the nuclear solution to inflation.

No one is being fooled by the pause in the decline of the Euro which is expected to resume once this week’s monetary policy meetings have taken place.

Yesterday, it rose to a high of 1.0718, but quickly ran out of steam and fell back to close lower on the day at 1.0679.

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.