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US and EU inflation set to show further signs of slowing

As we come to the end of the week, month, and quarter it’s not been a great quarter for equity markets. There’s been a significant shift in sentiment over the summer as economic data has deteriorated and expectations around how long interest rates are likely to stay high have shifted well into 2024.

European markets look set to open higher after US markets managed to rebound into the close, after treasury yields retreated from their highs of the day to finish the day lower.  

Today’s economic data is likely to feed into some of this narrative, even if a lot of it is quite backward-looking, like the final revisions for UK Q2 GDP which will show a UK economy that is in a much better place than was thought to be the case at the time, but ultimately tells us very little about where the economy is now. For this we will need to look at the latest mortgage approvals and consumer credit numbers for August, which are due at 9.30am.

The most recent iteration of UK Q2 GDP showed an economy that is in better shape than originally thought, while recent revisions from the ONS announced at the beginning of this month suggest that we could see a further upgrade to the 0.2% growth we saw at the beginning of August. Expectations had been for a slowdown from the 0.1% seen in Q1, however a strong June GDP number of 0.5% put any thought of stagnation in Q2 very much on the back burner.

The strong showing in June was driven by services as the hot weather prompted consumers to go out and spend money on travel, hotels and restaurants, as well as other leisure pursuits. We also saw a strong performance in construction and manufacturing with strong motor vehicle sales. The weak spots were in health and education due to industrial action, and while the resilience of the UK economy is welcome given the tough cost of living backdrop there is a concern that this could be as good as it gets as we head into Q3 and the second half of the year.

On a more up to date note the most recent set of lending data for July clearly showed that higher rates are starting to bite, after mortgage approvals slowed more than expected in July to 49,400, while consumer credit slowed to £1.2bn from £1.6bn. In a sign that interest rate hikes are starting to work, the latest M4 money supply data showed a sharp contraction of -0.9% on an annualised basis, which was the weakest reading since early 2015.

This appears to have acted as a warning to the Bank of England that monetary policy is tight enough already, with the recent pause announced earlier this month. With interest rates at their highest levels since 2008 and house prices starting to slide back, the demand for new mortgages could well slow further, with 47,400 approvals expected, particularly since the school holidays tend to see a seasonal slowdown as people go on holiday.

We also have the latest flash CPI from the EU for September which is expected to show a sharp slowdown from the levels seen in August after Germany CPI slowed sharply to 4.3% yesterday from 6.4% the previous month. EU headline inflation remained unchanged in August at 5.3%, when many had been expecting a a slowdown to 5.2%, although core prices did slow to 5.3% from 5.5% so there does appear to be progress on core prices, which are expected to slow to 4.8%. With the ECB hiking rates by 25bps, a couple of weeks ago, officials on the governing council will be hoping for further respite from elevated inflation levels with today’s flash numbers for September expected to slow to 4.5% at a time when the wider economy continues to show worrying signs of stagnation.

The sharp rise in yields over the last few days also speaks to a concern that we could see further rate hikes from central banks in the coming months, despite a general feeling that we’ve hit a peak as far as the ECB and the Bank of England are concerned. Today’s US inflation and personal spending numbers could go some way to tempering expectations about a November rate hike from the Federal Reserve. With the Fed pausing rates earlier this month, US central bankers will be hoping that the recent tick higher in headline CPI is merely a temporary phenomenon and something that doesn’t start to impact on personal spending patterns.

Personal spending remained strong in July rising by 0.8%, however the rise in gasoline prices since then could well start to impact on a wider level while also helping to put a floor under inflation, with expectations for a rise of 0.5% in August. On the core PCE deflator measure which is the Fed’s preferred measure of inflation targeting this edged higher in July to 4.2%, and is expected to slip back to 3.9% in August. The deflator rose to 3.3% from 3.2%, and is forecast to move up to 3.5%.

The Federal Reserve has continued to suggest that they may look to hike rates again in November if inflation doesn’t show further signs of coming down. Today’s numbers need to show that further downside is possible when it comes to core inflation for the prospect of a further rate hike by year end to recede.      

EUR/USD – rallied off the 1.0480 area yesterday where we may have seen a short-term base. A move below 1.0480 retargets parity. The main resistance remains back at the 1.0740 area, which we need to get above to stabilise and minimise the risk of further weakness.  

GBP/USD – broken a run of 6 daily declines rallying from 1.2110, with the bias for a retest of the 1.2000 area. We need to see a recovery through resistance at the 1.2300 area in the short term. Only a move back above the 1.2430 area and 200-day SMA stabilises and argues for a return to the 1.2600 area.    

EUR/GBP – slipped back towards the support at the 0.8620/30 area before rebounding. Needs to overcome the 0.8700 area and resistance at the 200-day SMA at 0.8720, which is capping the upside. A break of 0.8720 targets the 0.8800 area, however while below the bias remains for a pullback. Below 0.8620 targets 0.8580.

USD/JPY – still on course for the 150.00 area with support currently at the lows last week at 147.20/30.  A break above 150.00 retargets last year’s higher at 152.00. Major support currently at the 146.00 area.

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