11 September 2023: Economy to stay about positive

The data that is due to be published this week will go a long way towards determining the path for Sterling for the rest of the year.

Tomorrow, the August employment report will be released. It is expected that the claimant count will have increased marginally while earnings have exceeded inflation, meaning that in real terms, people will begin to feel better off.

Inflation is likely to have moved slightly higher since the rising cost of a barrel of oil is reflected in the forecourt price of petrol and diesel. The data will show that the inflation is well on the way to meeting Rishi Sunak’s pledge to halve the rate of inflation by the end of the year.

The economy will have shrunk by up to 0.3% in August but the Q3 results due next month are expected to show marginal positive results. With inflation falling and the economy “bumping along the bottom,” the conditions that will lead to an end to interest rate hikes are slowly appearing on the horizon.

Several economists believe that the next meeting of the MPC will agree to a hike of twenty-five basis points in the base rate, but that could be the last in this cycle.

The Chair of retail giant John Lewis has called for the Government to act over the situation in UK high streets which are becoming like “ghost towns.”

The increase in rents and business rates has seen several famous brands disappear over the past few years. The reasons for this are broad based and varied.

The evolution of online shopping has meant that it is convenient for shoppers to buy anything without leaving home, while post-Pandemic Britain has seen a significant shift towards home or hybrid working. The savings in rental costs for office space made by service industries in particular mean that this trend is likely to continue.

Sterling has come under significant pressure over the past few weeks as the dollar makes a recovery and support offered by continual fate hikes appear to be ending.

Last week, the pound fell to a low of 1.2445 and closed at 1.2466. As we reach the end of the third quarter of the year the final hikes in interest rates will be seen from G7 Central Banks as growth prospects, rather than inflation, take centre stage.

The August inflation report is due for release on Wednesday and although the headline will have risen, driven almost totally by the rise in gasoline prices at the pump, the passing of Labor Day which generally signals the end of summer should mean that the price rise will have had less effect on consumers than would have been seen previously.

The month-on-month figures are expected to see a rise of 0.5%. As the FOMC considers another pause in interest rate increases, the figures will confirm Jerome Powell’s latest two comments in which he said that a pause not the end of hikes can be expected, and that the path of inflation towards the Fed’s target of 2% is not going to be “linear”.

No stock market indicator can accurately predict the short-term path of the markets and with usually reliable long-term indicators like the Confidence Board index of Leading Indicators and the inversion of the yield have so far been defied, the prospects for the economy in the final quarter of the year are positive.

While there are those who still want to believe that a recession is coming and that a soft landing is an “impossible dream,” the major banks and investment houses are beginning to believe.

While a “goldilocks scenario” in which the economy is neither growing at such a rate that inflation becomes an issue, or growth is so hard to find that a recession is possible, is hard to achieve the FOMC is now in a position where inflation is close to coming under control and the economy is beginning to pick up speed.

With interest rates at a critical juncture any change to monetary policy could have a significant impact. The employment data that has been seen over the past few months has seen that while some cooling has taken place new jobs are still plentiful. Given that jobless claims are averaging close to 230k per week, there has been some rebalancing of the market taking place.

The dollar index has certainly “bought into the soft-landing scenario. It is currently enjoying its longest winning streak for nine years. Last week it completed its eighth consecutive week of gains, climbing to a high of 105.15 and closing at 105.05.

This is the longest positive “streak” since winter of 2014/2015. It has gained 5% since July.

The long-running saga of the end of the cycle of rate increases by the European Central Bank and the possibility of that happening this month, is ending.

While, on balance, the market believes that the Governing Council will agree a further twenty-fine basis point increase when it meets later this week, the feeling is that rates are already in a restrictive state, and a further rise will see the economy suffer overall, just as some individual states, like Germany and Italy are suffering already.

The opposite view, upheld by countries including Austria, Slovakia and Latvia is that rates need to be increased at least once more given that inflation is both far from under control and, if left, will cause more harm to the economy in the long-term.

Most of the Frugal five have tempered their hawkish comment recently with the Belgian and Finnish Central Bank Heads avoiding the limelight while Klaas Knot the Governor of De Nederlandsche Bank has said that the market may be underestimating persistent inflation and tightening financial conditions threaten to tip economies into financial instability.

Knot is also the Chair of the Eurozone Financial Stability Board.

The President of the Bundesbank has hardly spoken in public since his return from holiday, while the fifth member of the Frugal five, Robert Holzman from Austria has continued to demand a hike this week.

Christine Lagarde, the ECB President has noticeably dialled back her calls for a further rate hike, although she has not gone as far as predicting a pause. It is certainly too much to expect individual nations to vote for monetary policy that is aimed at the common good, particularly there is no such thing as the common good currently. Whether there is a hike this week or not, some nations will see it as being like a wrecking ball for their economy, while others will take it in their stride.

Therein lies the paradox of monetary union; one size, unfortunately, does not fit all.

The euro has fallen consistently since the market concluded that tighter monetary policy may do more harm than good. Last week, it fell to a low of 1.0686 and closed at 1.0700.

Have a great day!