Sterling Faces Inflation Test as the Dollar Loses Rate Support
Summary
Sterling enters the week after better-than-expected UK growth helped it gain against both the dollar and the euro
UK labour market figures on Tuesday and inflation on Wednesday will be closely watched ahead of the Bank of England’s September meeting
The dollar has weakened as softer US employment, inflation and retail sales data have reduced expectations of a Federal Reserve rate rise next month
Federal Reserve minutes and final euro area inflation figures are also due on Wednesday, putting interest-rate expectations firmly at the centre of the week
Sterling begins the week with some momentum. Better-than-expected UK growth data helped the pound finish last week higher against both the dollar and the euro, while weaker US economic releases pushed the dollar lower. The result is a week in which the focus shifts from what happened to growth last quarter towards what employment and inflation now mean for the next decisions from the Bank of England and Federal Reserve.
The British economy grew by 0.4% in the second quarter, slowing from the first three months of the year but continuing to expand. June itself was stronger, with monthly GDP rising by 0.3%, driven by growth in services. Those figures reinforced evidence that the economy has remained resilient despite the energy shock that has shaped much of this year’s inflation outlook.
Attention now turns to the labour market on Tuesday and inflation on Wednesday. The previous labour report put unemployment at 4.9%, while regular earnings growth stood at 3.4%. Consumer inflation, meanwhile, eased to 2.6% in June, although services inflation remained higher. These releases are particularly important because disagreement inside the Bank of England has been growing. Six members voted to keep rates unchanged in July, while three wanted an immediate increase. The Bank’s next decision is due on 17 September.
The backdrop in the United States has moved in the opposite direction. July payroll employment fell, consumer inflation eased slightly and Friday brought an unexpected decline in retail sales, the first in nine months. That sequence has reduced expectations of a September Federal Reserve increase and put the dollar under pressure. By Monday, futures markets were assigning roughly a 70% probability to the Fed leaving rates unchanged next month, a marked shift from a month earlier.
Wednesday’s Federal Reserve minutes will therefore arrive into a very different market backdrop from the one that existed when policymakers met in July. At that meeting, the Fed voted 9–3 to keep rates unchanged, with three members preferring a quarter-point increase. The minutes will provide more detail on that disagreement, although the meeting itself took place before the latest employment, inflation and retail sales figures were released.
Europe adds another dimension to the week. The European Central Bank raised rates in June before leaving them unchanged in July, maintaining its position that future decisions will depend on incoming data rather than a predetermined path. Euro area inflation was estimated at 2.9% in July, slightly higher than in June, with energy again the largest source of price pressure. The full July inflation report is due on Wednesday.
That leaves the major currencies facing different questions at the same time. Britain enters the week following stronger growth but with inflation still above target. The United States has seen a run of softer data reduce expectations of an immediate rate increase. In the euro area, policymakers are still assessing the inflationary effects of elevated energy prices after June’s rate increase. Both the Bank of England and ECB have explicitly identified the Middle East energy shock as an important source of uncertainty for their inflation outlooks.
Events to Watch This Week:
Tuesday 18 August: UK labour market data; US industrial production
Wednesday 19 August: UK CPI for July; euro area inflation for July; Federal Reserve minutes from the July meeting
Friday 21 August: UK retail sales for July; UK public sector finances
For sterling, Tuesday and Wednesday provide the most significant domestic data test of the week. At the same time, the Federal Reserve minutes arrive after recent US data have already caused markets to scale back expectations of a September rate increase. With inflation, employment and central-bank policy all in focus, the coming days carry clear event risk for businesses with sterling, dollar and euro requirements.
Speak to the Orbis dealing team ahead of this week’s key releases to discuss your upcoming transfers and the risk-management options available.
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