UK inflation held at just above the Bank of England’s 2% target in August, cementing expectations that policymakers will cut interest rates again later this year.

Consumer prices rose 2.2% from a year earlier, the same pace as in July and below the BOE’s forecast, the Office for National Statistics said Wednesday. The reading was in line with the median expectation of economists surveyed by Bloomberg. Downward pressures from motor fuels, restaurants and hotels were offset by an upward push from air fares.

The figures are likely to keep the BOE on track for a further loosening in policy in coming months after it cut rates for the first time since the pandemic on Aug 1, citing easing underlying inflation. They will also be welcomed by the new Labour government, which is banking on lower inflation and borrowing costs to help fuel the growth it says is needed to fix ailing public services and boost living standards.

Services inflation, a key gauge that has worried the BOE, rose to 5.6% in August from 5.2% in July. However, a pickup had been widely anticipated and is expected to prove temporary. Both services inflation and the headline rate are running below levels forecast by the BOE in August of 5.8% and 2.4%, respectively.

While policymakers are expected to leave rates unchanged at 5% at their decision on Thursday, market expectations of further easing have been mounting. Traders are pricing in cuts for both November and December with five more to follow in 2025.

The pound gained 0.2% to US$1.3183 after the data was released, with investors focusing on still-high services inflation as stymieing the outlook for aggressive monetary easing. Traders marginally pared bets on BOE rate cuts over the remainder of 2024, seeing 48 basis points versus 50 basis points on Tuesday.

“The pick-up in services inflation was the standout feature of August’s CPI report but it’s unlikely to worry the Bank of England. The rise was driven by volatile airfares and the gauge continues to track below the central bank’s August forecast. Despite that, we still think the chances of the BOE unveiling a rate cut on Thursday are low. The next move down will likely come in November,” said Bloomberg economists.

The BOE decision this week will be announced a day after the Federal Reserve is expected to kick off its own easing cycle amid fears about the health of the US economy.

There are also concerns the UK economy is losing steam, with figures last week showing GDP flatlined for a second month in July after outpacing all of its Group of Seven peers in the first half.

Monetary policy remains restrictive and energy bills are set to rise from October, putting upward pressures on headline inflation. Meanwhile, Chancellor Rachel Reeves is expected to announce tax hikes in her Oct 30 budget to fill what she claims is a hole in the public finances left by the previous government.

The ONS said that the 22% monthly rise in air fares was the second-largest in the category since records began in 2001, driven by flights to European destinations. Prices for flights typically climb between July and August but fell last year, meaning it helped to push up the annual rate of headline inflation this year.

There were fewer signs that the return of Taylor Swift’s tour to London fueled price pressures, as it did in June. While hotel price-inflation cooled, annual price growth in the cinemas, theaters and concerts category still jumped from 4.4% to 9.2%.

“While the Bank’s Monetary Policy Committee will be reassured by today’s data, they’re likely to remain wary of loosening policy too quickly,” said Martin Sartorius, principal economist at the Confederation of British Industry. “Inflation is expected to pick up later this year and domestic price pressures, such as wage growth, still pose an upside risk to the outlook.”

There was further evidence that pipeline inflation pressures are receding. Factory gate prices that are paid by retailers rose by just 0.2% in August on last year — below forecasts for a 0.5% increase.

Input prices, paid by manufacturers, fell 1.2% on the back of a sharp decline in oil and fuel costs. Markets had expected a drop of 0.8%. Food input prices rose, partly as a result of a poor potato yield, the ONS said.

BOE governor Andrew Bailey has advocated a cautious approach to reversing the most aggressive policy tightening in decades. However, he has also signalled growing confidence that the central bank is beginning to contain stubbornly high price pressures from the services sector and jobs market.

He said last month that second-round inflation effects have been “smaller than we expected,” though he stressed that the “job is not completed.”

“Inflation completes a set of major September economic data a little softer than rate-setters expected, but pretty close to their expectations,” said Rob Wood, chief UK economist at Pantheon Macroeconomics. “We expect headline inflation to fall to 2% in September, as a strong September 2023 services price gain depresses the year-over-year inflation rate this year and airfares unwind some of their August gain.”

Source: Theedgemarkets

The Mexican Peso (MXN) notes a modest weakness in its most heavily-traded pairs during the European session on Wednesday, falling in particular against the Pound Sterling (GBP), which broadly appreciates after the release of UK inflation data. 

Mexican Peso down against the Pound 

The Mexican Peso is currently down by over a third of a percent against the Pound Sterling after the release of higher-than-expected UK services and core inflation data for August, which wiped out any hopes of the Bank of England (BoE) cutting interest rates on Thursday. A rate cut had been speculated, which would have put a lid on GBP strength since lower interest rates generally attract less foreign capital inflows. Given that it is now highly unlikely, Sterling is appreciating. 

UK headline Consumer Price Index (CPI) in August met expectations of 2.2% year-over-year (YoY) and remained unchanged from the previous month, whilst core CPI rose 3.6% YoY when 3.5% had been expected from 3.3% in July. A rise in Services inflation, which has been a key issue for the BoE, was the final nail in the coffin for hopes of a rate cut. 

“..but the rise in services inflation 5.2% to 5.6% suggests the Bank of England will almost certainly press the pause button on interest rate cuts on Thursday. We continue to expect the next 25 basis point rate cut to take place in November," said Ruth Gregory, Deputy Chief UK Economist at Capital Economics. 

Big day for the US Dollar as Fed set to announce rate cut

The hot topic for markets is still whether the Federal Reserve (Fed) will cut interest rates by a bigger 50 basis points (0.50%) at the conclusion of its meeting on Wednesday or opt for a standard 25 basis point (bps) cut – 0.25% in percentage terms. 

The outcome is likely to cause volatility in the US Dollar (USD) and its pairs, US stocks, and broader global financial markets. A larger rate cut will weaken the USD, leading to a fall in USD/MXN. A smaller cut is probably already priced in. 

The Fed’s accompanying Statement of Economic Projections (SEP), with its projected path for interest rates in the future based on officials’ views, as well as growth and inflation forecasts, could also impact markets and FX. 

Dalio weighs in on 25-or-50 debate

In an interview with Bloomberg News on Wednesday, Ray Dalio, CIO of Bridgewater Associates, said that the Fed would be looking to balance the needs of creditors to earn a real yield (the gain from debt interest after inflation) with the desire to lower interest repayments for debtors.  

“25 pbs would be the right thing to do if you are looking at the whole picture. If you are looking at the mortgage situation, which is worse – and affects more people – then it’s probably 50 bps,” Dalio said. Based on the economic data alone, he said the “(US) economy is very close to an equilibrium level, except for the debt situation.” “Significant socio-economic and political factors, including polarization in both, were further variables to consider,” added Dalio.

The probability of a larger 0.50% cut stands at 61%, as implied by 30-day Fed Funds futures prices according to the CME FedWatch tool, whilst the probability of a smaller 0.25% cut stands at 39%.

Technical Analysis: USD/MXN nears bottom of channel

USD/MXN has declined within a broad rising channel, forming a Three Black Crows Japanese candlestick pattern on the way down (shaded rectangle) last week. The pattern indicates the probability that prices will fall even lower in the short term. That said, they are already nearing key support at the base of the channel. 

USD/MXN Daily Chart 

Although USD/MXN has fallen quite far already, the odds favor more weakness to the next downside target and support level at 19.01 (August 23 low), followed perhaps by further weakness to the 50-day Simple Moving Average (SMA) at 18.99 and then the lower trendline of the larger channel a few pips below. At that level, the price will likely find firm support to stabilize and perhaps recover in line with the broader medium and long-term trend. 

A decisive break below the lower channel line would indicate a reversal in the medium-term trend. This is a possibility given the risk of volatility on the horizon from the Fed’s announcement and the speed and steepness of the decline so far. 

A decisive break would be one accompanied by a long red candle that pierced well below the channel line and closed near its low, or three down days in a row that broke clearly below the line.

Source: FXSTREET

The Philippine central bank is looking to cut banks’ reserve requirement ratio significantly before yearend, according to governor Eli Remolona, a move that’s expected to unleash billions of pesos into the financial system.

“We will reduce the reserve requirement substantially this year, and then there may be further reductions by next year,” Remolona said at a media briefing in Manila on Wednesday. He didn’t specify the extent of cuts in the RRR, currently at 9.5% of deposits that bigger banks must set aside in reserve.

The governor’s comments come a month after the Bangko Sentral ng Pilipinas kicked off a rate cut cycle to lower the benchmark interest rate from a 17-year high. While the BSP had long stressed that the reserve requirement isn’t a monetary policy tool, it held off from triple R cuts during Remolona’s term so as not to cause confusion.

Banks have long sought lower RRR from the BSP to trim their costs and free up billions of pesos of funds required by the authorities to be locked in their vaults. Bank of the Philippine Islands, one of the country’s largest lenders, had even proposed a conditional, instead of a uniform reserve requirement cut, according to a GMA News report last month.

“There’s a funny dynamic going on: the banks want a reduction in reserve requirement, and they’re saying that if you do reduce it, we will do this other thing for you, reduce transactions cost for payments, for example,” the governor said. “So we are trying to manage that.”

As for its next interest rate move, the BSP will focus on the country’s data, instead of the action of the Federal Reserve, which markets expect to start lowering interest rates this week for the first time in over four years.

“What the Fed will do is one data point for us. It’s not most of the data,” Remolona said. The BSP’s next policy meeting is set for Oct 17. Earlier this year, the governor said that he wants to slash the triple R to 5% by the end of his term in 2029.

The BSP last lowered the triple R in June 2023, when Remolona’s predecessor, Felipe Medalla, cut the ratio by 2.5 percentage points to 9.5%. That move was estimated to have released 325 billion pesos (US$5.8 billion or RM24.6 billion) into the financial system.

Source: Theedgemarkets

Markets

August US retail sales were supposed to provide final input yesterday as investors concluded their positioning going into today’s Fed policy decision. Overall the report was marginally stronger than expected (headline sales +0.1% vs -0.2% expected after a strong upwardly revised 1.1% in July, core control group sales 0.3% M/M as expected but July upwardly revised to 0.4%).

It is very unlikely that it will have a material impact on the Fed’s decision making. Still, the report provided somewhat of a trigger for some investors to take profit on Fed-easing bets after the recent protracted rally.

US yields rebounded between 5.4 bps (5 2-y) and 2.8 bps (10-y). Markets still see a 60% chance for the Fed to start with a 50 bps step this evening. German yields in sympathy followed a similar trajectory (2-y +4.4 bps, 30-y -0.2 bps). The Dow (-0.04%) and the S&P 500 (+0.03%) touched new intraday record levels early in the session, but gains could not be sustained.

Intraday dynamics in yields (modest rebound) and equities (correcting off the highs) also kept the dollar away from nearby support levels. DXY closed at 100.89 (vs key support at 100.51). EUR/USD stalled ahead of the 1.1155 intermediate resistance (close 1.1114). USD/JPY rebounded from 140.6 to 142.4. Oil still tries to develop a bottoming out process of the sharp decline earlier this month (Brent $73.25 p/b).

Markets will finally get the Fed verdict today. We prefer a scenario of Powell and co starting with a substantial reduction of policy restriction (50 bps) to avoid an unnecessary weakening of the labour market. Current high policy yield levels allow to do so. It still leaves the Fed the option to make a revaluation on both inflation and growth with the policy rate above neutral (end this year/early next year).

In this scenario, an assumed additional cumulative 75 bps of easing signaled in the median dot plot for the remainder of the year might still support recent dynamics of markets staying asymmetrically sensitive to softer than expected activity/labour market data.

The message from the dots for 2025 might be much less aggressive than what markets are currently discounting, but it’s probably too early as a driver for markets in the near term. In this context we also stay cautious on the dollar.

This morning’s UK August CPI data also brought tomorrow’s BoE policy decision back in the spotlights. The report was perfectly in line with expectations. Headline inflation printed at 0.3% M/M and 2.2% Y/Y (unchanged from July). Core inflation rose 0.5% M/M and 3.6% Y/Y (from 3.3%). Services inflation also stays elevated at 0.4% M/M and 5.6% Y/Y (from 5.2%).

Especially the monthly dynamics in core and services inflation indicates that there is little reason for the BoE already to take another advance on easing inflation after the August 01 in augural rate cut. Sterling strengthens from EUR/GBP 0.845 to 0.844 in a first reaction after the release.

News & Views

Andrius Kubilius, former prime minister of Lithuania and the EU’s first-ever defense chief, said that the EU can’t wait until the next 7-yr budget in 2028 to increase its defense spending. While that’s still a national authority, he wants to support the fragmented industrial military base. He suggested exploring the option of issuing joint bonds to raise an additional €500bn or to tap the bloc’s bailout fund or use unspent money from the Recovery and Resilience Facility. The debate on issuing more mutual (EU) debt is gaining again more and more momentum since Mario Draghi published his report on competitiveness.

The Bank of France left its growth forecast for next year unchanged at 1.2% and slightly lowered the 2025 prognosis to 1.5% from 1.6%. Governor Villeroy said that the French economy is recovering from the acute illness of the last two years: inflation. Now we must treat our two chronic illnesses of too much debt and not enough growth, he added. The national bank lowered its average inflation forecast for next year from 1.7% in June to 1.5%, mainly due to weaker electricity prices. Inflation is set to average 2.5% this year.

Graphs

GE 10y yield

The ECB cut policy rates by 25 bps in June and in September. Stubborn inflation (core, services) make follow-up moves less evident. We expect the central bank to stick with the quarterly reduction pace. Disappointing US and unconvincing EMU activity data dragged the long end of the curve down. The move accelerated during the early August market meltdown.

US 10y yield

The Fed in its July meeting paved the way for a first cut in September. It turned attentive to risks to the both sides of its dual mandate as the economy is moving to a better in to balance. The pivot weakened the technical picture in US yields. A string of weak eco data and a risk-off market climate pushed and kept the 10-yr sub 4%. We think we could be up to three 50 bps rate cuts this year.

EUR/USD

EUR/USD moved above the 1.09 resistance area as the dollar lost interest rate support at stealth pace. US recession risks and bets on fast and large rate cuts trumped traditional safe haven flows into USD. EUR/USD 1.1276 (2023 top) serves as next technical references.

EUR/GBP

The BoE delivered a hawkish cut in August. Policy restrictiveness will be further unwound gradually on a pace determined by a broad range of data. The strategy similar to the ECB’s balances out EUR/GBP in a monetary perspective. Recent better UK activity data and a cautious assessment of BoE’s Bailey at Jackson Hole are pushing EUR/GBP lower in the 0.84/0.086 range.

Source: ACTIONFOREX

Koreans, on average, hold debt exceeding twice their annual income, according to data from the Bank of Korea, Wednesday.

Data released by Rep. Cha Gye-geun of the minor Rebuilding Korea Party revealed that the overall loan-to-income (LTI) ratio in the first quarter of this year stood at 233.9 percent.

The figure, which peaked at 238 percent in the second quarter of 2022, has been decreasing since then, falling to 233.9 percent in the fourth quarter of last year. However, it has remained at this level in the first quarter of this year.

All age groups, except those in their 50s, saw an increase in their LTI ratio in the first quarter of this year compared to the previous three months.

The ratio of those aged 30 and younger rose from 238.7 percent to 239 percent.

The ratio among individuals in their 40s increased from 253.5 percent to 253.7 percent, while rising from 239.1 percent to 240.8 percent for those aged 60 and older.

In contrast, the ratio of those in their 50s decreased from 208.1 percent to 205.6 percent, displaying a relatively lower level.

The figure for those in their 40s is particularly noteworthy, as this age group holds a total debt balance exceeding 2.5 times their annual income, the highest debt ratio across all age groups.

Cha attributed this high debt ratio to the practice of maxing out available loans to purchase homes, driven by their high prices.

According to data from Statistics Korea, the average debt held by households where the head is in their 40s was 125 million won ($94,000) last year. Of this amount, 72.7 million won, or 57.9 percent, consisted of mortgage loans.

Additionally, in the first half of this year, the balance of mortgage loans for those in their 40s at the four major banks — KB Kookmin, Shinhan, Hana, and Woori — rose by 8.1 trillion won compared to the end of the previous year.

“Those in their 40s, who should be the backbone of domestic consumption, have fallen into a debt trap,” Cha said.

“The increase in the LTI ratio is attributed to rising home prices and increasing mortgage loans. It is crucial for the government to find solutions to stabilize home prices.”

Source: Koreatimes