4 September 2023: Inflation will fall but rates will still rise

4 September 2023: Inflation will fall but rates will still rise


  • The UK outstrips the Eurozone despite Brexit
  • Unemployment rate rose in August despite “robust” NFP
  • Italy’s Economy contracted further in Q2
GBP – Market Commentary

5.5% is the popular choice for the summit of base rate

The UK economy performed at a far higher level than had been previously considered in the immediate post-Pandemic period. In fact, despite being the first G7 Central Bank to hike interest rates, a course of action that is continuing and looks likely to endure into the final quarter of the year, the UK economy outstripped that of the Eurozone.

Also, hampered by the issues surrounding Brexit, the UK was like the G7 average. The leader of the Opposition, Sir Keir Starmer has seen a major part of his election strategy torn apart, although his intention to make the UK the strongest economy will be made earlier should he become Prime Minister sometime in the next fifteen months.

It will be an almost incredible feat if the Government were to be able to turn around its abysmal record since the 2019 election to close the gap on Labour despite some almost unbelievable failures.

It is the nature of politics in the UK that the country “tires” of Parties that have remained in power for more than a decade.

There are two significant examples in the modern era. First, Margaret Thatcher, an incredibly divisive figure who, love her or hate her, impressed her personality on Parliament, eventually was brought down by her own ministers then, Tony Blair, who realized that a hard-left dominated Socialist Party had become almost unelectable.

Somehow, the Conservative Party has stumbled through the past thirteen years, first in coalition with the Lib Dems and then since 2015 in sole charge.

A succession of weak, untrustworthy, and politically naive leaders has come and gone since then leaving the country with another Prime Minister who understands the power of surrounding himself with talented people who are prepared to be unpopular in the name of progress.

Several commentators believe that the Bank of England will raise interest rates at its upcoming meeting but that will be the last hike in this cycle. The Market is expecting base rate to top out at 5.50% now with fears that it may hit 6% fading.

This week, there is, again, no tier one data due for release. There are only updates to the output data for the economy and the Halifax survey of house prices due to be published. For this reason, Sterling will remain driven by events elsewhere, while the market ponders the end of rate hikes.

Last week, Sterling was driven lower by events in the U.S. and fell to a low of 1.2577 and closed at 1.2790.

USD – Market Commentary

Powell “hoping” for weaker demand and slower job creation

The August employment report, released on Friday was unusual in as much as it chimed with both the private sector and job openings reports to paint a mixed picture of the economy.

The economy added a further 187k new jobs in August, an identical number to July before it was downwardly revised in the latest report. It is likely that the August number will also be revised, given that it was published on the first day of the month, which means that several estimates of the data will have been included.

While new jobs created showed an unexpected degree of growth, the unemployment rate rose from 3.5% in July to 3.8% last month. This means that there has been a shift, regional or, more likely, sector driven in the market. Other data in the report like hours worked and earning were at, or slightly below, market expectations.

The marginal slowdown in earnings growth may be significant to the FOMC which will meet in two weeks’ time to agree on any change to the fed funds rate.

The market is still leaning toward another pause, since there were “several” votes for a pause last time and little has changed in the interim period, so it would be something of a surprise if there was another hike this time, despite Jerome Powell’s marginally hawkish speech at Jackson Hole.

In the employment report, some of the less considered figures are beginning to attract attention. This is characteristic with the end of a rate cycle where analysts are trying to squeeze every ounce of justification for their opinion.

Job openings fell below nine million, while temporary jobs fell by 19k, and the average work week inched higher.

The August inflation data which will be published next week will now be eagerly awaited to provide a more definitive view of the FOMC meeting. In the meantime, ISM services output data is due for release On Wednesday. It is expected that these will remain well into expansive territory, which will further alleviate fears of a coming recession.

Weekly jobless claims figures remain well above the 200k “watershed” figure which points to a cooling jobs market. While not openly pleased by this, Jerome Powell will see it as further confirmation of a soft landing.

The dollar index remains well supported, but unable to make a significant move higher as G7 monetary policy remains in a state of flux. It reached a high of 104.29 last week and closed close to that level at 104.26.

EUR – Market Commentary

While inflation was low the ECB failed to consider the future

Over the past ten years the ECB has gone from having a comfortable stroll through its monetary policy meetings to its every move being studied through a lens of international as well as “domestic” scrutiny.

It is as well that a politician like Christine Lagarde was made President since she is used to being second guessed by journalists. Her predecessor, Mario Draghi, was more pragmatic, being a technocrat who was more used to doing what was right in policy terms and far less concerned with how things looked to the outside world.

GDP data for Draghi’s home nation of Italy was published last week. It showed that in the second quarter Rome saw the economy falter even further. It contracted by 0.4% QoQ, which led to YoY growth of just 0.4%.

The parlous state of the Italian economy will have been laid at the door of the ECB, which the Italian Government has accused of “economic vandalism” due to its constant tightening of monetary policy over the past year.

It was widely expected that a pause in rate hikes would be considered at the next meeting of the Bank’s Governing Council, but the hawks remained firmly in control. There may well be a shock in store in three weeks’ time, but no one is willing to make that prediction.

The treatment of inflation by the ECB has become a hot topic not just in Frankfurt, but throughout the entire European Union. Whether it is even possible to decide the level of interest rates for twenty vastly different economies is even possible, particularly when each can decide its own fiscal policy is a question for the ages.

When monetary union was agreed more than two decades ago, several major factors appear to have been left to chance. As it stands, of course Germany and Austria would want to see rates at elevated levels given their abhorrence of inflation while Greece, Italy, Spain, and Portugal would have a more relaxed attitude given their familiarity with soaring prices.

The Governing Council believes that its role is to set monetary policy given the facts that are before leaving high level policy decisions to the European Commission and Parliament both of which have proven to be ineffective.

Today, both Lagarde and Bundesbank President Joachim Nagel will make speeches. Neither is likely to give too much away about the outcome of the rate-setting meeting, but Nagel, not having spoken in public for some time, will be expected to set out Germany’s view of tighter monetary policy, given its being in recession in all but name.

Last week the Euro suffered at the hands of a stronger dollar. It fell to a low of 1.0772 and closed at 1.0776.

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.