Chris Doane
September 20, 2021

UK Inflation ‘Slighly Above’ BOE’s Forecast

GBP

The pound to euro exchange rate edged marginally higher last week although the currency pair’s trading range remained tight. Many analysts expect the pound to euro exchange rate to start this week in the same manner as markets await the Bank of England decision this Thursday.

UK inflation was slightly higher than the BOE’s forecast, rising to 3.2 percent in August and many, the BOE included, expect this to rise above 4 percent later this year. During the same period, July’s GDP figures were below expectation and August’s Retail Sales data also disappointed a second consecutive decline. This makes Thursday’s BOE decision more interesting as the UK struggles to deal with rising prices and a slower economy.

Andrew Bailey, BOE Governor, told parliament’s Treasury Select Committee, “I think we’re seeing some flattening out of the rate of recovery. Actually, across quite a broad range of indicators that we look at.” Bailey went on to say, “we don’t have a precise story to tell to explain it.”

An upbeat outlook from the BOE could push the pound to euro exchange rate towards 1.18 although recent data suggests the UK economy is tracking slightly behind the BOE’s forecast, but will this be enough to deter BOE policy, which to date has provided support to the pound.

Markets have already priced in a 0.1% rise in the UK interest rate for early 2022 and many analysts expect the BOE to be one of the first central banks to tighten policy, particularly following recent comments from both Governor Bailey and Deputy Governor Broadbent suggesting conditions have been met.

However, uncertainty remains around the furlough scheme, which is due to finish this month. The jobs market has been a strong performer in previous months, returning to pre-pandemic levels, and some predict unemployment levels to continue to fall, even in the wake of the furlough scheme ending. In fact, July recorded record job vacancies.

Whilst the BOE decision will be the key event of the week, HIS Markit PMI data covering services and manufacturing will be released before the BOE’s decision on Thursday. Data is expected to show both sectors expanding but likely falling month-on-month due to global supply chain issues.

EUR

With less than two weeks to go to the German election and the successor of Angela Merkel is confirmed, opinion polls continue to show Olaf Scholz, the center-left candidate, in the lead. Olaf Scholz is widely viewed as a good successor to Merkel, more so than Angela Merkel’s Christian Democratic Union candidate Armin Laschet, who is less experienced. However, what’s concerning investors is Scholz’s openness to a coalition with the hard left.

German European Central Bank member, Isabel Scanel, has said that “in all likelihood,” Eurozone inflation will reduce significantly next year, although on the other hand, ECB Chief Economist Phillip Lane told bankers privately that an interest rate hike in the Eurozone could happen within the next two years, the ECB subsequently denied this report.

European Covid-19 cases remain low, and a general loosening of restrictions sooner than the UK has kept the Eurozone economy arguably performing better than the UK, although, like the UK, the Eurozone could likely face rising Covid-19 cases as we enter the winter months.

Elsewhere, Australia, the US, and the UK have launched AUKUS which is a trilateral security pact, whereby the US and UK will support the build of nuclear submarines for Australia, which has led to the cancellation of a £72.5 billion contract with the French. Macron and other French ministers have been lashing out at the three Anglo-Saxon allies, who form part of the intelligence-sharing group Five Eyes, but as one expert put it, Macron can’t be trusted and is too aligned to EU culture. Whilst French media has rounded on the UK in particular, German media has been quick to point out the humiliation of the petulant French Prime Minister who has been clearly side-lined by western allies on this big security decision.

USD

US retail sales data was considerably better than analysts had forecast showing an increase of 0.8 percent as opposed to a decline as many had anticipated, and other core economic data was also supportive of the US economy, despite sentiment being weaker.

The big question that has been riding for some time is when will the Federal Reserve cut its $120 billion per month bond-buying scheme. Some insight may come when the Fed releases its “dot plot,” which is the US’s outlook for the path of interest rates.

Given Fed Chair Jerome Powell did not announce a policy change in his crucial Jackson Hole speech, the Fed is unlikely to make an imminent change, but analysts will look for hints in a possible change as soon as November. Markets will be keen to understand the Fed’s view between asset tapering and rate hikes, along with the central bank’s view on the economy, and more.

The US also needs to address the issue of its debt ceiling, which could cause chaos if there was to be a government shutdown, although markets have been less concerned here and ultimately, this issue will likely not gather traction until October when the risk of the Government running out of money and defaulting becomes a possibility.

Covid-19 cases in the US remain high but the increase in vaccination numbers has been encouraging, although the sustainability of this pace is questionable as both the UK and Eurozone have found.

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