Stagflation concerns spread to our shores

Recap

Only two weeks ago fear of stagflation hit the EUR, dragging the currency lower. Yesterday, job numbers from the UK are now bringing those fears home, with the unemployment rate rising and the number of job losses at the highest since 2020. Over in Europe the latest ZEW survey showed sentiment is weakening in Europe as well. With stocks lower on the day as well, USD was the currency that benefitted most.

The EUR gained yesterday evening after a Reuters report, citing an unnamed source, that tomorrow the ECB will hike its inflation forecasts for next year, which has firmed up the expectation of a 0.25% hike in tomorrow’s meeting, i.e. hike largely priced in by markets. At the same time the ECB are expected to cut 2023 and 2024 economic growth projections.

Today

Market rates

* Daily move - against G10 rates at 7:30am, 13.09.23

** Indicative rates - interbank rates at 7:30am, 13.09.23

Data points

Speeches

None today.

Our thoughts

Going forward it seems that FX markets will now be dictated by growth differentials as opposed to the interest rate differentials that have driven FX markets for the last 12 months – which benefitted GBP and EUR. The US economy is continuing to expand, whereas growth in Europe and the UK is expected slow or even contract. Add to that investors can get around 5% in money market accounts, you can see the extra allure of USD. Data this morning from the UK showed that growth went from 0.5% in June to -0.5% in July – adding to the stagflation narrative for the UK following yesterday’s job numbers.

So where next for the EUR following that Reuters report? Whilst the EUR gained off the leaked report, the gains were far from impressive and with the longer-term warning signs of stagflation ringing loudly, it seems the markets are reluctant to go long on EUR (push EUR higher). Tomorrow’s rate hike is now largely priced in, and whether the ECB hikes or not hikes the EUR could well face a lose – lose situation tomorrow.

Today’s inflation numbers will be key to support the Fed's higher for longer interest rate narrative, and thus keep supporting the demand for USD. Headline inflation is expected to rise, but as ever it’s the core number that will be key and support treasury yields.

Chart of the day

The impending fear of stagflation is mounting. Inflation in the UK remains high relative to the country’s peers in the G10, whilst growth is slowing and unemployment is at its highest for 2 years. GBP has been well supported the last year on the back of interest rate expectations, but now that we are near the end of the cycle, should data continue to support the stagflation narrative then this will increase the likelihood of weakness in GBP, and ultimately increase the cost of importing.

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