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Jamie Jemmeson
August 17, 2022

Inflation hits a 40-year high

European Central Bank expects a technical recession

Sterling had mixed fortunes in the first half of the week, weakening before strengthening this morning. On Tuesday, the UK labour data was disappointing. The number of jobless claims in July decreased by 10.5k against 26.8k a month earlier and the expected 32k. To put further context on this, the number of people receiving benefits amounted to 1.53 million, 0.3 million more than before the first lockdowns, whilst job vacancies fell for the first time since August 2020. The loss of momentum will be seen as a forward-looking indicator that foreshadows more challenging conditions.

This morning, the sterling picked itself up as interest rate expectations following the release of the inflation data. Inflation hit 10.1% in the 12 months to July, up from 9.4% in June, the Office for National Statistics (ONS) said. This is the highest reading in 40 years and is set to push higher based on the BoE forecasts.

With higher inflation readings, we are seeing an acceleration in the implied interest rate moving forward. There is a 40% probability that interest rates could be at 3.75% in May 23, surpassing the US. The BoE has a tough job controlling inflation while attempting to promote growth. This is further complicated by the Conservative leadership contest and what policies roll out of that battle.

The market will now focus on the UK retail sales for a further handle on the impact that the cost of living crisis is having on the economy, which are due out on Friday.

Dollar underpinned by risk-off trading and hawkish Fed

The US dollar continues to advance in the early stages of this week as disappointing economic data across leading economies raised fresh concerns over a global recession, increasing safe-haven flows. The dollar was further underpinned by hawkish comments from Fed members, signalling that a pivot towards a dovish policy outlook is unlikely despite signals that inflation may be peaking.

Investors will pay close attention to the Fed speaker due to adding comments this week for fresh clues over the central bank’s rate path. Economic data released on Tuesday saw US industrial output beat estimates of 0.3%, rising by 0.6% in July from the previous month meanwhile Manufacturing output rose by 0.7%

It was a quiet start to the US economic calendar this week. The second half of the week includes releasing US Retail sales and industrial production data, along with updated housing activity. The highlight release comes from the Fed Minutes report on Wednesday, which will offer markets an early insight into whether the Fed members will vote for a 50-basis point or 75-basis point hike at the September meeting.

At the most recent July meeting, Fed Chair Powell wanted to see further evidence that inflation is returning towards the target before considering a significant change in the pace of tightening.

Euro remains under pressure ahead of GDP and Inflation data

Caution prevailed on Tuesday, which saw the euro come under renewed pressure from a stronger US dollar. Risk appetite remains suppressed across financial markets, increasing concerns of a potential global recession.

Further problems surround the current gas levy, which could keep German inflation higher for an extended period and cause more headaches for the European Central Bank (ECB). On Tuesday, the Economic Sentiment Index component of the ZEW Survey for Germany reported a drop to -55.3 in August from -53.8 in July. This reading came in worse than the market expectation of -53.8. Meanwhile, the Economic Sentiment Index for the eurozone fell to -54.9 from -51.5 and below expectations of -42.5 by a wide margin.

Looking ahead to the remainder of this week, investors will review the preliminary GDP Growth rate for Q2, set for release on Wednesday and followed by the final core inflation rate numbers due for release on Thursday.

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