Michael Addis

Market Commentary

For the week ending 20 July 2018
Report by Michael Addis
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Michael Addis

Events over the past week have resulted in investors reappraising the likelihood that the Bank of England will increase interest rates in less than two weeks’ time on 02 August. Although a rate increase remains more likely than not, the probability has fallen to around 80%, having started the week at closer to 90%.

Sterling resumed its downward move below $1.30, in part due to comments from the US Federal Reserve Chairman Jay Powell, on the positive outlook for the US economy, in his testimony to the Senate banking committee, which served to highlight the diverging paths of the US and UK.

The Office for National Statistics reported that UK employment growth remained strong at 137,000 in the three months to May, and the unemployment rate was unchanged at 4.2%, the joint lowest level since 1975. Despite this, the annual growth in average weekly earnings moderated to 2.5%, from 2.6% in April. Although leading indicators suggest pay growth should increase over the coming months, the persistent lack of meaningful wage growth remains a concern.

Consumer price inflation unexpectedly remained at 2.4% year-on-year in June, missing expectations of an increase to 2.6%. Clothing and footwear prices fell by 2.1% between May and June, the biggest decline for the month since 2012, which offset the rise in energy prices. The increase in producer price inflation from 9.6% to 10.2%, which should feed into consumer prices over time, was of interest to the inflationary bulls, but the overall news on inflation detracted from expectations of an imminent interest rate increase, even though it means that employees are now enjoying real pay increases.

Thursday’s data release revealed that UK retail sales fell by 0.5% month-on-month in June, against expectations for a 0.2% rise, enhancing concerns over the near-term health of the UK economy. However, this weakness was largely attributed to the distraction of the World Cup, which had kept consumers out of the shops.

On the political front, Theresa May’s Brexit plan only just survived a series of votes in the House of Commons, which adds to the uncertainty on whether she can negotiate a deal with the European Union (EU) that is acceptable to Parliament. Betting markets now show a 43% probability that the UK will not leave the EU by the end of March next year.

The Monetary Policy Committee faces an increasing dilemma. On balance, it does appear that the weakness seen in the UK economy in the first quarter of this year was largely temporary and it would be useful to return interest rates to a more “normal” level from which to cut, when the next downturn inevitably comes. However, the slight cooling of this most recent data, coupled with still elevated uncertainty around the UK’s eventual relationship with the EU, suggests that a rate increase next month has the potential to inflict more harm than good.