Another rate rise looms despite inflation’s big fall

No end in sight to the run of UK interest rate rises and uncertainty over the summit for US borrowing costs ensured the poor August for stock markets continued today.

The FTSE 100 index weakened to a fresh one-month low at 7339.4 by the time of Wall Street’s opening bell, meaning the top flight has lost almost 5% this month.

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China’s run of poor economic figures and ongoing uncertainty over the likely summit for rates on both sides of the Atlantic have clouded the investment case since a strong July.

Today’s inflation figures in the UK did little to help matters after yesterday’s blockbuster wage growth, even though the headline rate fell broadly in line with expectations to 6.8%.

The fly in the ointment came from services inflation, a key metric watched by the Bank of England that rebounded by more than forecast from 7.2% to 7.4% year-on-year.

Deutsche Bank believes this reading “lowers the bar” for another forceful hike by the Bank of England’s monetary policy committee (MPC) on 21 September.

Markets have already priced in a near 25% chance that the MPC delivers another 0.5% hike, a move that would take the base rate from 5.25% to 5.75%.

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This week’s surprise rise in the unemployment rate to 4.2% and drop in headline inflation means Deutsche Bank economist Sanjay Raja still errs on the side of a quarter-point hike.

One more set of labour market and inflation data is due prior to the September decision, although a repeat of the beats on wage growth and prices in the services sector could mean the odds tilt firmly to a half point rise next month.

The pound today rose 0.4% against the US dollar to $1.275, another factor putting downward pressure on overseas earning stocks in the FTSE 100.

The stubborn nature of UK inflation means the City is no closer to knowing whether September’s anticipated increase is the last in the cycle. 

Julian Jessop, economics fellow at the Institute of Economic Affairs, believes rising unemployment and falling vacancies suggest that wage pressures will soon peak.

He added: “Unfortunately, the Bank of England continues to look backwards at the headline data over the last month or two, rather than pause to assess the impact of the substantial tightening in policy that is already in place. This makes another unnecessary interest rate increase more likely.”

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US interest rates appear closer to their peak but fears that borrowing costs may have to stay high for longer have clouded Wall Street sentiment in recent sessions.

July’s quarter-point increase took the target range to between 5.25% and 5.5% but with Federal Reserve policymakers still signalling one final hike later this year. 

However, this week’s strong retail sales figures and robust data on housing starts have heightened jitters over the outlook ahead of tonight’s release of minutes from the central bank’s July meeting. 

Capital Economics said recently it expects the Federal Reserve to begin cutting rates in the first half of next year as disinflation gathers pace. It anticipates up to 200 basis points of cuts next year, which is roughly 75 basis points more than priced into futures markets.