27 July 2023: Government cheered by IMF review


  • Bank of England faces renewed pressure over a possible recession
  • FOMC hikes again after a one-month pause
  • Lagarde to reinforce the “higher for longer” narrative
GBP – Market Commentary

UK remains in the economic slow lane

When the IMF produced its last global review, the Government pushed back against its findings believing that the economy would not contract for the requisite two consecutive quarters this year that constitute a recession.

In its latest review, the Fund reversed its prediction and agreed with the Government’s view that although it would be “nothing to write home about”, the UK economy would grow in 2023.

The IMF believes that the UK economy will grow by 0.4% this year, up from a prediction of a 0.3% contraction in its last global review.

While any growth is welcome in the current environment, the economy will remain in the “slow lane” when compared to most other G7 economies. Way out ahead in the “growth race” is the United States, where 1.8% growth is predicted.

While the right-wing English press gloried the fact that the German economy will underperform and be the only economy in the group that grow more slowly than the UK, the fact is that with an election on the horizon, Rishi Sunak will need to perform a miracle or rely on the Opposition, completely blowing their substantial lead in the opinion polls to be re-elected.

The IMF praised the UK for the improvements that have been seen in consumption and business investment, but it still sees Brexit as a drag on exports and the lack of progress on free trade deals, particularly with the U.S., as hampering the economy.

Goldman Sachs, the pre-eminent investment bank, believes that the Bank of England will hike by a further fifty basis points at its next meeting, which will take place a week today. Although it is predicted that there are seventy-five basis points of hikes, they are the only major bank that is predicting such a degree of front-loading.

With inflation remaining stubbornly high, such an idea has merit, particularly given that up until the last meeting, the cycle of twenty-five-point hikes had been ineffective in slowing demand.

The pound has seen a particularly volatile month, and this is likely to continue until the traditional “August slowdown” takes place. Yesterday, Sterling continued to claw back its losses from earlier in the month. It reached a high of 1.2977 and closed at 1.2966.

Versus the Euro, it has seen substantial gains as the Bank of England is expected to at least match the hike that the ECB will deliver later today, while the economic picture is brighter than in the Eurozone, which will contract until the first quarter of 2024.

USD – Market Commentary

Door left open for more hikes later in the year

The FOMC hiked the fed funds rate to 5.25% at the conclusion of its meeting yesterday.

Its Chair, Jerome Powell, in his press conference following the meeting, commented that the Central Bank can afford to be patient, as well as resolute when considering further rate hikes. He was asked when he felt that rates would begin to fall. He answered that when we are comfortable with a rate cut, that is when it will take place, but it is unlikely to be this year.

Given the acceleration in the fall that has been seen in inflation in the past couple of months, it is likely that rates are now restrictive, and yesterday’s hike was more about “stamping out” price increase completely rather than a measure to bring them down.

The market believes that the FOMC has now entered a “hawkish pause,” and some believe that there will be no further increases in the fed funds rate, which has now reached a twenty-two-year-high this year.

With the labour market softening, the latest data will be released next Friday, the Fed is prepared to “wait and see” if a soft landing can be achieved, but the outlook is favourable.

Leaving the door open to further hikes later in the year, Powell acknowledged that policy would need to be restrictive for longer than had at first been considered.

Even having varied the size of rate hikes, it has still taken longer than expected for rates to become restrictive, but there had to be a cautious approach given the effect that raising rates too quickly would have had on the economy.

The wait for the publication of the July inflation report will be relatively short. It is due for release on August 10th, and it is clear that Powell and his colleagues believe that a further significant fall will be seen.

The dollar index lost ground in the aftermath of the rate decision. The market feels that although the U.S. will suffer by comparison with the Eurozone and the UK, even though its economy is expected to vastly outperform both over the rest of the year.

It fell to a low of 100.68 and closed at 100.83.

EUR – Market Commentary

Pressure growing for central banks to reduce their bond portfolios

Christine Lagarde faces a tough day in attempting to justify the latest hike in Eurozone interest rates in the face of an economy that is in danger of “falling off a cliff” and the news that the region’s largest economy will be the worst performing in the G7.

The fact that Germany is one of the most vocal supporters of higher interest rates, not just at this meeting but continuing well into the Autumn, well provide some solace, but there will doubtless be howls of protest from the Heads of Central Banks and Government Ministers from nations who are struggling with downturns in their economies that can be almost entirely attributed to the constant hiking of interest rates.

Following the past two meetings, Lagarde has been quick to head off any discussion about the future by confirming that rates will continue to rise.

This time, as the Governing Board takes a month off to enjoy the summer, she will face less encouragement, not just because it is felt that she is overstepping her mandate but also because now that rates are definitely in a neutral position and have possibly become restrictive upon demand, the August break should be taken to consider the evidence of what has taken place so far with a clean slate with no preconceived idea of what will take place at September’s meeting.

There will be data for July and most of August to consider before any decision is made, and there will be plenty of demands for a pause which will come from Italy, Portugal, and Spain with support from nations that have been supporters of further hikes in the past.

Support for the far right collapsed in Spain in the snap election that took place on Sunday, after four years of left-wing rule. The Centre-right PP Party won the largest number of seats but failed to reach a majority and will have extreme difficulty forming a government.

The outcome is likely to be a further election in the Autumn.

In its latest global economic review, the IMF upgraded its prediction for the Spanish economy, considering its improved tourist revenues and falling rate of inflation. Any further rate hikes after today will make the Bank of Spain’s task more difficult to raise find to fund any growth in the economy.

The Euro remains supported by the continued tightening of monetary policy.

That may change later today if Christine Lagarde softens her hawkish rhetoric, lessens her stance on a rate hike in September.

The common currency rose to a high of 1.1106 yesterday and closed at 1.1086.

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.