Risk of inflation harming recovery fades
A fall in the cost of raw materials helped push inflation lower in July. Headline inflation fell to 2% while core inflation which excludes volatile items like food and energy fell to 1.8%.
This fall will be welcomed by Bank of England policymakers as it gives them a little breathing space over a tightening of monetary policy, allowing them to ensure that the recovery is robust.
It is likely that inflation will rise again as we head into Autumn, but analysts now expect the peak to be 3.5%, which undershoots the Bank’s estimate of 4%.
The expiry of several discounting schemes introduced by retailers last year will see inflation rise again, meaning that last month’s fall could be a one off
One significant contributor to the fall in inflation last month was the continued reopening of the economy, which increased in particular the availability of services.
This, as well as the fact that new cases of coronavirus, following the further removal of restrictions, appear to be lower than predicted means that the logistics sector will be able to gain traction, although this area was the largest contributor to inflation in July, offset by falls in the price of clothing, footwear, and some recreational services.
There will have been some anomalies in the YoY data caused by the partial reopening of the economy last July, and the Bank’s analysts will adjust for this when advising the MPC on the trend for inflation.
A rush to beat the stamp duty holiday saw house prices in England rise the largest amount in seventeen years last month. Property inflation rose buy13.2 YoY in July, pushing the average cost of a house to 266k. This increase equates to a rise of £2.5k per month.
While this will add to concerns over a bubble in the property, next month should see the data come back more into line as the support provided to the Government fades.
The pound continues to be affected by the strengthening of the dollar over recent sessions. Yesterday it rose to a high of 1.3786 before falling back to close at 1.3754. Overnight it has fallen again as the effect of the FOMC minutes is felt. It is currently (05.00 BST) trading at 1.3720, where three is a degree of technical support.
USD – United States Dollar
July minutes confirm Autumn taper
The minutes of the latest FOMC meeting were published last evening, and they did nothing to dampen market expectations that the taper in monetary policy support will begin sooner rather than later.
There was a serious discussion of the plans for the reduction of asset purchases, although there is no confirmation of when they will begin. Comments made by Regional Fed Presidents since the meeting reinforce the view that the reduction will commence in October.
St. Louis Fed President James Bullard spoke yesterday of his expectation that not only would the taper begin in the Autumn, but that it would be complete by the end of the first quarter. He went on to say that he sees growth at 7% this year and 4% next, with inflation remaining, on average, close to 2.5%.
It was made clear in the minutes that the reduction of asset purchase will not be a precursor to a hike in interest rates and that the Fed Funds rate remains the Bank’s main monetary policy tool. This is in line with Jerome Powell’s comment this week that the Fed is preparing to put away its emergency tools.
There was a clear air of optimism regarding the continued level of growth of GDP.
The minutes are three weeks old and in the current environment that is a significant period, but with the next meeting not until towards the end of next month it is expected that the weaker than expected data that has been seen over the past week will be seen for what it probably was; a bump in the road.
The dollar index continues to threaten to break higher. Overnight it has rallied to a high of 93.49 and remains close to that level. That is a new high for 2021.
While the FOMC minutes eclipsed all other data released yesterday, numbers for housing starts and new permits were released. They saw new starts fall while permits rose. This is a clear indication of the shortage of raw materials and could lead to a continued rise in house prices as it brings a potential shortage of stock in some areas of the country.
EUR – Euro
Rising energy costs drive inflation
Inflation continues to be a challenge to the ECB. Data released yesterday showed that CPI rose by 2.2% year-on-year in July. On a monthly basis, core CPI fell by 0.1%. This will provide little comfort to the more hawkish members of the Governing Council, who forecast a faster pace of inflation in the coming months.
Inflation data across the entire region fails to paint a complete picture, given that there are several hotspots such as Germany where inflation is far higher than the average. Estonia, Poland, and Hungary posted the highest rates of inflation in July, all seeing price increases north of 4.5%
Construction data was also released yesterday, and this showed a worrying fall that illustrates perfectly the difficulties created by both a shortage of building materials and the difficulties being faced by the logistics sector.
Estimates for GDP for the rest of 2021 and 2022 continue to be revised upwards. The latest estimate is for GDP to be 4.8% this year and 4.5% next.
Is against a background of rising inflation and the level of support for the economy remaining as it is this year and remaining in place until March’22 before being replaced by a more permanent mechanism.
Employment is also on the rise, with a 0.3% fall in Q1 becoming a 0.5% increase in Q2. Jobs data provides another series of anomalies brought about by the inconsistency of the data and the difficulty in tracking those who are constantly on the move.
The euro has broken below major support overnight, driven by the stronger dollar. It has so far reached a low of 1.1665and is currently trading at 1.1675.
Having broken the support, a period of consolidation at lower levels is expected before a further assault on the lows from November last year around 1.1600.