25 August 2023: Markets still discounting two further rate hikes

Although some progress has been made in the fight against inflation, interest rate futures markets are still discounting two further hikes this year. There is also a long-held view amongst economists and market commentators that the base rate will top out between 5.25% and 5.75%, although it would take a significant rise in headline inflation for another fifty basis points in hikes to receive support from the MPC.

This week’s output figures were “disappointing,” but do show that the Bank of England, despite the market’s opinions, is closer to stopping rate hikes than it was previously believed.

There is no fixed rule or standard by which to judge when rates have become restrictive upon demand.

It is a judgment call which will be made by the MPC. Again, it is unlikely that any decision will be unanimous since at least one independent member who already believes that rates are sufficiently restrictive and need to be allowed to “do their work.”

The Bank of England was the first G7 Central Bank to commence rate hikes and the odds now are that it will be the last to call a halt. There is hope but truly little expectation from traders that any hint will be given at next month’s rate-setting meeting that a pause will be considered, let alone an end to the cycle.

Inflation is expected to continue to fall for the rest of this quarter at least and possibly into the first half of Q4. The two main components of volatility in the headline, energy costs and scarcity of certain basic foodstuffs are expected to fall further.

As rates continue to become restrictive on demand, the Bank of England will become more aware of the effect of higher borrowing costs on both domestic and commercial activity.

The level of interest rates clearly influences all aspects of the property market including rental values.

Monday’s holiday will guarantee a slow start to the final week of the “Summer lull”. It is likely that volatility will begin to increase later in the week with liquidity and activity returning to pre-summer levels.

There are no tier one data releases next week. This will concentrate the market on any changes that may happen in monetary policy in the coming weeks.

Yesterday, Sterling was under pressure for the whole day. It fell to a low of 1.2501 and closed at 1.2601. The proximity of significant support may mean that this may be the start of a new trend as the market returns to full capacity.

Timing is the most critical factor in managing a soft landing for the economy. Pause tightening too soon, and you run the risk of a resurgence in inflation, pause too late or leave them at elevated levels too long and the damage done could lead to a recession.

Fed Chairman Jerome Powell will be acutely aware that decision time is looming large, and it will require his lawyers’ skill to make the correct call.

Powell will make what is an eagerly awaited speech at the Jackson Hole Symposium that he is hosting, later today.

As is usual, there have been no leaks or advance notice given about what he will say, but it would severely damage confidence in the Fed if he failed to at least touch upon monetary policy.

Powell is expected to give his view on changes in the outlook for the global economy over the past twelve months. He has an extensive “library” of topics to choose from, from inflation to the pandemic, and the situation in Europe to the Chinese economic slowdown.

There will be little or no controversy or inflammatory remarks, since that is not the man’s style.

Other members of the FOMC have been speaking in advance of the start of the Symposium. Philadelphia Fed President Patrick Harker spoke yesterday of his view that there is a case to be made for ending rate hikes now.

His colleagues, James Bullard of St Louis and Tom Barkin of Richmond also had differing views. Bullard is concerned that the pace at which the economy is recovering may mean that further hikes are necessary, while Barkin is yet to make his mind up and declined to prejudge the September FOMC meeting.

With such a wide range of opinions, it will be hard for a decision to be made next month, while Powell will want to project a unified single voice to avoid any post meeting conflict.

The dollar index broke above minor resistance yesterday, reaching a high of 104.02 as the previous day’s data was taken as a sign that a soft landing is still achievable while other G7 economies appear to have recessionary pressures.

It closed at 103.92 as the market prepares for today’s possible volatility.

“Too close to call”. This is the market’s view of the upcoming meeting of the Governing Council of the ECB. The hawks’ “trump card,” the hawkish attitude of ECB President Christine Lagarde no longer has the effect it had at previous meetings, yet with four weeks to go until a monetary policy decision must be made, a lot of things could change.

The most pressing of those, is the publication of inflation data for individual states and the entire Eurozone next week.

It is predicted that headline inflation in the region will have remained at, or close to, 5.3%, with no meaningful fall expected. Core inflation is seen as rising marginally from 5.5% to 5.6% or 5.7%.

Spain, which has inflation under control and has the lowest headline rate may be the first of the “larger” economies to achieve the ECB target of 2%.

Given the fact that politicians and bankers are slowly returning from their annual holidays over the coming days, a greater reaction to the inflation data can be expected than was seen recently.

Although there is already pressure for a pause to rate hikes to be agreed at next month’s meeting, the more hawkish members of the Council will want to avoid the impression that the fall in inflation that has taken place recently has stalled.

If that is the case, then a further hike will be seen as warranted. Even the most hawkish member of the Council will see that the economy is in danger of a full-scale recession and the harm that could do to both political and social unity is plain to see.

Italy is already close to recession and has recently received a rebuke from the ECB for imposing a windfall tax on the profits of its banks.

The French economy is keeping its head above water and President Macron appears to have weathered the unrest that often foments in his country in the Summer.

Economically, Germany is enduring its worst month in three years, as output has “fallen off a cliff”, particularly in the services sector, which was seen as the country’s only hope of avoiding a recession.

The single currency saw its long-awaited fall begin in earnest yesterday. It fell to a low of 1.0805 and closed at 1.0810. Any feeling that the ECB may be turning more dovish will see the fall accelerate, as will a challenge of the long-term support at 1.0690.

Have a great day!