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Concerns of higher inflation and a weakening economic outlook weigh on the pound

The pound bears the brunt of the slump in the UK Consumer Sentiment, which hit a record low in August. Last week’s UK inflation report was a timely reminder that price pressures remain a key issue. The UK’s weaker economic outlook is likely to accentuate concerns surrounding the BOE’s next policy move, with interest rates expected to move another 175-basis point before the middle of next year. In economic data released last week, the May UK employment figures missed expectations, falling to 160k from 296k in April.

Meanwhile, the July UK inflation report (CPI) came in much hotter than anticipated at 10.1%, up from +9.4% on an annualised basis. The data was closely viewed following June’s UK GDP report, which showed that the UK economy contracted in the three months through June by -0.1% from +0.3%. While not technically stagflation, the UK economy continues to evolve in that direction.

Towards the end of last week, the UK’s Office for National Statistics reported that Retail Sales rose by 0.3% on a monthly basis in July, following June’s contraction of 0.2%. Although the print came in better than the market forecast for a decrease of 0.2%, sentiment weighed on the pound, losing ground against several major trading pairs and compounded by weaker than expected consumer spending.

The coming week’s data calendar is relatively light as we approach the end of August. This week, there is only one high-level data release for investors to review, which comes in the form of the flash August PMI survey report, scheduled for release on Tuesday.

Re-emergence of risk aversion support extends the dollar rally

The US dollar preserves its ongoing rally, reaching multi-week highs against the pound and euro in response to worsening economic conditions and risk aversion re-emerging. The dollar continued to attract support towards the end of last week following the release of upbeat Jobless Claims data and the Philadelphia Fed Manufacturing Index. The resumption of the solid demand for the dollar appears propped up by recent hawkish comments from Federal Reserve (Fed) policymakers.

Last week, a host of Fed members provided commentary, including observations from San Francisco Fed President Mary Daly and St. Louis Fed member James Bullard. Both defended a possible 75-basis point raised at September’s meeting, commenting that they expect rates to be in the 3.75% – 4.00% region before the end of this year.

Meanwhile, Fed member Esther George, a renowned hawk, suggested that economic growth would suffer. He said he is not sure the Fed can reduce inflation without triggering a recession. Last week’s Fed minutes contained no hawkish surprises. The general tone signalled that it may become appropriate to slow the pace of policy rate increases while assessing the effects of cumulative policy adjustments on economic activity and inflation.

This week’s key events on the US calendar include the US Fed annual economic symposium at Jackson Hole. In the past, Fed Chair Jay Powell’s comments were widely viewed by market participants, often providing an important update on Fed policy. Investors will look for signals on the size of the likely rate move in September and fresh clues surrounding the possible peak in rising inflation and any pullback in the current pace of policy tightening. The likelihood is that his message will be hawkish, highlighting that not only do they want to see a fall in headline inflation but are equally focused on whether domestic inflationary pressures – such as the tight labour market – have settled.

Attention turns to ECB July Minutes report

According to several leading economists, the headwinds for the eurozone economy will likely extend into winter. A continuing threat of gas shortages and high energy prices weigh on the growth outlook. Discussions about whether the ECB will raise its key rate by 25 or 50-basis points in September underscore how clearly the European Central Bank (ECB) lags behind the Fed and the Bank of England (BOE). This presents a problem for the euro as the growth outlook becomes increasingly gloomy. The standout economic data release from the Eurozone last week reported that the German Producer Price Index (PPI) jumped to 37.2% on a yearly basis in July from 32.7% in June. This print came in much higher than the market expectation of 32%.

Eurozone PMI manufacturing and services and consumer confidence data will release on Tuesday this week, the highlight release on the economic calendar. Meanwhile, on Thursday, the minutes from the ECB’s July policy meeting, when interest rates were raised by more than 50-basis points, will be watched for clues on the size of the expected second hike in early September. The ECB faces a similar dilemma to many other central banks with the inflation data arguing for aggressive action. In contrast, the activity indicators show the need for a more cautious approach. Nevertheless, markets think a second successive 50-basis point hike is the most likely outcome.

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