ECB, US Retail Sales and Trouble on the Tracks for HS2

Yesterday saw the ECB raise rates by 25bps on their main refinancing operations (to 4.5%), marginal lending facility (to 4.75%) and the deposit facility (to 4%). This marked Frankfurt’s tenth consecutive rate hike and brings the main refinancing rate its highest level its highest level in 22 years while the deposit facility reached an all-time high. While the 25bps hike had not been fully priced in, the euro came under pressure given some dovish comments over inflation, discussed below.

Behind the decision, the ECB citied in their Monetary Policy Statement how “inflation continues to decline but is still expected to remain too high for too long”. Interestingly, these were the exact same words used to open their previous Monetary Policy Statement released on 27 July where the central bank similarly raised rates 25bps. Since then, eurozone headline inflation (annualised) remained unchanged between July and August at 5.5%, though core inflation (annualised) eased from 5.5% to 5.3% between the same period. While this was a welcome sight for policy makers, core inflation nonetheless remains 0.4 percentage points off the bloc’s all-time high.

Sticking with inflation projections, Frankfurt’s macroeconomic projections for the euro area see “average inflation at 5.6% in 2023, 3.2% in 2024 and 2.1% in 2025”. While this marks a marginal upward revision for 2023 and 2024 (given inflationary pressures from energy), it is nonetheless a downward revision for 2025, giving markets some hope that the central bank may taper rates sooner and faster than previously projected over the coming years.

Given that some commentators had seen poor German and French growth figures as a reason to hold rates, Frankfurt’s decision to raise rates again may put further pressure on the Eurozone’s powerhouses. As such, regarding growth, Lagarde’s press conference saw the governor of the ECB state that “the risks to economic growth are tilted to the downside”. Moreover, as monetary conditions continue to tighten and external demand slips, Lagarde continued in stating that the “economy likely to remain subdued in the coming months” as the European services sector comes under particular pressure. Markets now turn to Eurozone growth figures along with preliminary inflation data on 29 September.

Yesterday showed US retail sales climb from 0.5% to 0.6% on a monthly basis, far surpassing expectations of a 0.2% print and giving the latest indicator that much of the US economy is remaining resilient in light of monetary conditions being at their tightest levels since 2008. Increased spending was seen at clothing shops (which rose 0.9%), electronics (which rose 0.7%) and health & personal care (which rose 0.5%). Retail sales rising comes despite many US consumers’ savings accrued during covid being eroded. Indeed, as the Economist pointed out earlier last month “Research by Hamza Abdelrahman and Luiz Oliveira of the Federal Reserve Bank of San Francisco suggests that Americans have burned through more than 90% of the “excess savings” they amassed in 2020 and 2021. What little remains, the economists estimate, is likely to be gone by the end of September.” Indeed, over Covid monthly personal savings across the US rose sizeably to 30% (of income) from 9% the year before. Now, following tighter fiscal and monetary conditions, monthly personal savings have plummeted to just 4.3%. While the question of whether US households will get through their savings is still up for debate, some will question whether retail sales can continue to climb given the erosion of many household savings.

Yesterday, Downing Street seemingly refused to commit to whether HS2 will run into the North of England. This has driven up the already existing speculation that the Northern England leg could be axed as costs and delays continue to embarrass the government. Earlier this year a leaked document suggested that £2.3bn had already been spent on stage two between Birmingham and Manchester but £35bn could be saved by axing the phase all together. All eyes are now on how Downing Street will respond to the latest speculation as tracks continue to be laid.