European and UK Economic Insights ECB Policy and UK GDP Growth Revision

EUR: The return of the 'S' word

In a more extensive discourse, we are observing the resurgence of the term 'stagflation' as it pertains to the prospects of the eurozone economy. The European Central Bank (ECB) has finally come to acknowledge that economic growth is likely to be significantly weaker than their officially projected forecasts, all the while grappling with the persistent issue of core inflation remaining stubbornly above 5%. It is my belief that the ECB will proceed with their planned 25 basis points (bp) interest rate hike at their upcoming September meeting, but there is a growing chorus of dissenters who view this move as potentially erroneous.

In the backdrop of these monetary considerations, European politicians continue to engage in debates surrounding the reinstatement of the Maastricht debt and budget deficit criteria, which had been suspended during the height of the pandemic. While such a development might bode well for the stability of eurozone government bond markets, its implications for the euro currency, marked by tighter fiscal policies and a less stringent monetary stance, could be decidedly adverse.

For the present week, we do not anticipate any eurozone data releases that would substantially deviate from established trends. Nonetheless, a multitude of ECB officials are actively participating in discussions, positioning themselves regarding the final 25bp interest rate hike scheduled for September. The EUR/USD exchange rate is displaying signs of fragility, and although significant movement may not be expected today, a speculative market that remains predominantly bullish on EUR/USD might be compelled to unwind their positions should the modest support levels at 1.0760/85 be breached. Intraday resistance, on the other hand, could potentially materialize around the 1.0820 mark.

GBP: A welcome revision to GDP

The Office for National Statistics (ONS), the UK's national data office, provided a positive surprise to UK policymakers last Friday by upwardly revising the GDP growth for 2021 by 1.7%. This adjustment indicates that the UK rebounded to pre-pandemic growth levels much sooner than previously thought, highlighting that Germany now presents the weakest post-pandemic performance among G7 nations. Additionally, this revision may offer a bit more fiscal flexibility for the government, potentially sparking speculation about potential fiscal incentives in the Chancellor's Autumn statement scheduled for November.

Over recent days, the British pound has seen a modest improvement against the euro. It is expected to continue trading within the 0.8500-0.8600 range in the short term. While the upcoming week on the UK data front appears relatively quiet, Thursday's release of the Bank of England Decision Make Panel survey might draw some interest. A decrease in inflation expectations would be welcomed, but it is unlikely to deter the BoE from proceeding with its planned 25 basis points (bp) interest rate hike on September 21st.

Nevertheless, I maintain my belief that the market has priced in approximately 20bp more than necessary into the BoE's tightening cycle, and as a result, I anticipate the British pound to soften somewhat in the fourth quarter.

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