9 August 2023: Economy stalls. Have rate hikes become restrictive?

Since the Bank of England hiked short-term interest rates to 5.25% last week, and even before that, there have been several signals that interest rates have become restrictive on demand.

House prices continue to fall, with the Halifax House Price Index registering its fourth consecutive monthly fall, although the decline of 2.4% was less than June’s 2.6%.

The break in the weather after June’s almost unbroken sunshine probably influenced like-for-like retail sales. The British Retail Consortium reported that the data showed an increase of just 1.8% after June’s stellar rise of 4.2%.

There was further support for the view that interest rate increases are beginning to bite in a recent survey of hiring by small and medium enterprises, which showed that hiring decisions are being postponed or cancelled altogether, with the number of vacancies falling by 85k in July.

Although manufacturing output has become less and less important to the economy in recent years as the county’s service sector has grown, it is at its lowest level since before the Pandemic.

Optimism and interest rates have moved in opposite directions since the beginning of the year, while inflation has not behaved in the “traditional” manner.

There is more anecdotal evidence of a decline in confidence in the accounting firm BDO’s Business Trends Survey, which is at a level which generally points to a recession or at least a significant slowdown.

UK exporters are reporting a decline in orders particularly from China and the Eurozone, while a pickup in the U.S. economy is insufficient to “take up the slack”.

The growth in services output is insufficient to make up for the continued fall in manufacturing output.

If the Bank of England continues to hike interest rates, reaching their predicted level of 6%, the optimism that was generated by the IMF report in which it predicted that the UK economy would escape a recession this year is likely to be proved wrong.

The pound continues to decline as the dollar gains strength from the growing possibility that the U.S. economy will achieve a soft landing. It fell to a low of 1.2684 yesterday, although it managed to regain some ground late in the day to close at 1.2748.

A survey of business investment across all sizes of companies released yesterday shows that firms’ intention to invest over the next year or so, has declined to levels not seen since before the Pandemic.

The Fed’s return to hiking rates at its July meeting has led to a decline in borrowing intentions as rates have moved beyond neutral and into restrictive territory.

Following comments by two members of the FOMC in recent days which were opposite in their expectations for further rate hikes, a third, Philadelphia Fed President Patrick Harker, spoke yesterday of his view that the cycle of rate hikes had come to an end.

Harker, who is a voting member of the rate-setting committee this year, spoke of his belief that the economy has reached a point where the Central Bank can afford to be patient, hold rates at their present level and allow their previous actions for full feed through into the economy.

One thing that recent speakers agree upon is that rates are unlikely to be cut any time soon.

Over the first half of the year, there has been undoubted progress in the fight against inflation, and this has engendered renewed confidence in the economy that was badly affected by the Pandemic.

The resilience of the economy is now there for all to see, and a soft landing can now be looked forward to with renewed confidence.

Notwithstanding any alarming data that is published between now and the next FOMC meeting on 19/20, Harker will use his vote for a further pause.

At its June meeting, the FOMC was party to projections which showed the need for two or possibly three further hikes this year.

With one already having taken place, the odds now favour just one more, probably in October, although there is a possibility that the headline rate of inflation will have risen marginally when the data for July is published tomorrow.

The dollar index continues to gain strength from the comparative growth data between the U.S. and other G7 Members.

Yesterday it rose to a high of 102.80, but there are still some legacy sell orders around that level which pushed it back down to a close of 102.54.

In a worrying but far less chilling reminder of the hyperinflation which destroyed the German economy in the years immediately following the second world war, it is estimated that over two million German citizens are using food banks in some way or another to stave off the high inflation that has driven the cost of living to levels not seen in a generation.

Although the German people are prone to heightened levels of caution over inflation, the current situation may see the Bundestag and Bundesbank rein in their support for further interest rate rises.

As a dominant force in calls for inflation to be crushed, Joachim Nagel, the Bundesbank President, has been at the forefront of demanding higher interest rates and has drawn support from Christine Lagarde.

This may be the time for some introspection since the Eurozone’s largest and historically strongest economy is suffering more than almost all its neighbours.

Although there have been no nationalist murmurings yet, having supported the Eurozone when several of its members were suffering during the Pandemic, Germany now finds fighting inflation and cutting social services more than its more profligate neighbours.

The German people will feel entitled to ask: “When will it be our turn to return to prosperity?”

A eurozone-wide poll by the ECB conducted in June found that a majority believe that inflation will fall in the coming months, but there is still some pessimism about when it will reach the Central Bank’s target level of 2%.

House prices have remained constant during the period of rate increases, but this is more due to the sociological fact that fewer people in the Eurozone own their own homes than is seen in other developed economies, like the UK and the U.S.

Despite that house prices are beginning to fall as even the more affluent homeowners are seeing their mortgage costs rise significantly.

Inflation data for July was released in Germany yesterday, and it showed that the harmonized rate, which uses the same basket of goods as the rest of the Eurozone, remained unchanged at 6.5%.

The euro has been driven lower by a fall in comparative optimism between the U.S. and the Eurozone. Yesterday it fell to a low of 1.0929 and closed at 1.0956.

It is too early to say that the single currency has now waved goodbye to the 1.10 level, particularly considering the data that is due for release in the U.S. tomorrow. However, in the medium term, it is likely that the Euro has begun its long march lower, although its path is unlikely to be in a straight line.

Have a great day!