24 August 2023: Unemployment may need to rise to halt the Bank of England

24 August 2023: Unemployment may need to rise to halt the Bank of England


  • Economic activity slows in August as rate hikes bite
  • Manufacturing output is beginning to fade
  • Only one more hike is possible as economic output becomes an issue
GBP – Market Commentary

Services activity fell away badly this month

The Bank of England, in common with other global Central Banks, looks at trends in the economy and tends to consider “outliers” as just that, issues that are due to a specific event or issue.

Examples of this are the boost to GDP likely to happen due to the England women’s football team reaching the World Cup final, or the opposite effect of the additional Bank Holiday that was granted to the country to celebrate the King’s Coronation.

Yesterday’s release of preliminary output data for this month so far is likely to be treated similarly, but it is important to be able to discern the reason that data was out of line and not the beginning of a new trend.

The earlier the start of a new trend can be spotted the better for monetary policy, since it allows the Central Bank to get “ahead of the game.”

Services output has virtually collapsed, falling from a relatively healthy 51.5 in July to a severe contraction to 48.7 this month. This dragged the composite figure down into contraction territory at 47.9 from 50.8 last month.

The recent trend in the composite data has confirmed the “feel” in the market that the economy has been just about holding its collective head above water, but there will be urgent investigations taking place at the Bank of England to ascertain the reasons for the collapse.

If no clear and obvious one-off reason can be found, this will affect the thinking at the next MPC meeting which, until yesterday, was expected to agree to another twenty-five-basis point increase in short-term interest rates, since this data is no doubt a clear indicator of a looming recession.

Information will be gathered from several sources, but it is already considered likely that the cycle of interest rate hikes that has continued since December 2021 is now beginning to bite and this is affecting demand which in turn slows output.

If that is identified as the reason for the slowdown when taking seasonal factors into account, the market will change its collective view of the outcome of next month’s MPC meeting.

Sterling initially nosedived, falling initially to a low of 1.2614, but as the output data from other G7 nations was published, it recovered to close at 1.2726, since interest rate hikes in both the Eurozone and U.S. didn’t mean that the UK suffered by comparison.

USD – Market Commentary

Economic stagnation has reared its head

Using identical logic to the Bank of England, analysts, and economists at the Federal Reserve, will be poring over output data for this month which was also published yesterday.

It showed that the U.S. economy is also slowing, but that was more expected since the Fed is expected to announce another pause in its chain of interest rate hikes or the end of the cycle. That is now virtually “nailed on,” although the FOMC will want to see the August employment and inflation reports before making its mind up.

The composite figure for services and manufacturing output combined remains in expansion at 50.4 following a far healthier read of 52 in July.

Broken down, manufacturing continues to contract, at 47 this month, down from 49, as it has for a number of months. while services output has begun to slow noticeably, falling to 51 from 52.3.

While this is indicative of the soft landing that the Fed is hoping to achieve, a further rate hike would appear to be off the table if the other data for August is in line.

Investors will be concerned about the latest data which, on the surface, appear to confirm the two long-term indicators which are still predicting a recession within the next eighteen months to two years.

It is unlikely that Jerome Powell will allude to anything other than “business as usual” at his speech to the Jackson Hole Symposium which begins today. Powell will address delegates tomorrow in a speech that is eagerly awaited.

Despite the data, the economic engine appears to be “humming sweetly,” although it appears that consumer spending is gradually slowing. Again, this is a factor in the soft landing but must be monitored to ensure that the Fed doesn’t cross the line.

The dollar index reached 103.98 yesterday, its highest level since early June but ran into significant sell orders as the market did not want to get too far ahead of itself ahead of Powell’s speech. It settled back to close at 103.37.

EUR – Market Commentary

The downturn has deepened this month

The ECB is beginning to gain a reputation for being a little too concerned about the headline numbers for the entire economy and “painting with a broad brush.”

As is often said, the devil is in the detail.

There is still, and rightly so, a considerable number of data releases that relate to individual Eurozone economies, which should concern the ECB more than they do. This is testament to the influence wielded by Germany in general, and the Bundesbank in particular.

While the German economy will, in all probability bounce back from its current period of slow economic activity to such an extent that it can easily absorb further rate hikes, the Bundesbank still has an “unhealthy fascination” with rising inflation.

Italy on the other hand, with its exceptionally generous social programmes that have led to a debt-to-GDP ratio that is north of 130 and a budget deficit in express of the now outdated ECB measure of 3%, begs to differ.

The Italian economy is used to dealing with a far higher rate of inflation than Germany and while it has tended to go from boom to bust and back again, that tends to suit the Italian temperament.

When the European Union and ECB first came into being fiscal and monetary discipline was one of the main considerations, but that proved to be “too much” for several economies that saw their economies explode with growth but came close to collapse as borrowing levels reached unsustainable levels.

Germany is now far stronger than it would have otherwise been since it was looked upon to bail out nations and exerted significant measures to do so.

Now, it can pressure its Eurozone partners to treat rising inflation as the most significant issue facing the region currently even if several of its members disagree, sometimes quite vocally.

The output data published yesterday, can best be described as “mixed.”

In Germany, the composite index collapsed to 44.7 from 48.5, due to weakness in services output, which fell to 52.3 to 47.3.

In a normal world, this would make a pause in the cycle of rate hikes a cast iron certainty but the fact that uncertainty still exists is testament to the power that Germany still yields.

The Common Currency fell to a low of 1.0802 as it became more possible that its single support, tighter monetary policy, was about to be removed, but then a sense of the actual reality kicked in, and it rallied to close at 1.0864.

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.