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Week Ahead (31 July)

Monday, 31 July – Eurostat flash inflation estimate for July

Today, Eurostat will publish Eurozone’s flash inflation data for July. In June, Eurozone headline inflation was 5.5%, down from 6.1% the previous month, after peaking at 10.6% in October 2022. This is also the lowest euro-area year-over-year inflation rate since the beginning of 2022. However, an acceleration in services inflation offset the decrease in overall inflation, with core inflation rising to 5.4%.

In June, the ECB raised its inflation forecasts for the next two years, projecting that the headline rate will run at 5.4% in 2023, falling to 3% in 2024 and 2.2% in 2025. Against this backdrop, the European Central Bank (ECB) decided last week to once again raise interest rates by 25-basis points to 3.75%.

With inflation still being significantly above the ECB’s medium-term target of 2%, the release of inflation figures today may indicate whether core inflation has finally peaked. With bank lending and PMI data weakening, further hikes will increase the prospects of economic recession in the Eurozone.

Monday, 31 July – Another by-election likely to be announced in the UK

Today, it is highly likely that another by-election will be announced in the UK. More specifically, the recall petition for Rutherglen and Hamilton West MP Margaret Ferrier concludes today. The Scottish MP, who has been Independent since 2020, faced a suspension of 30 days from the parliament in June, after speaking in the Commons while awaiting Covid test results during the 2020 lockdown. If over 10% of registered voters in the constituency sign the recall petition, a by-election will be triggered.

This could serve as another tough mid-term test for Prime Minister Rishi Sunak and the ruling Conservative Party. Earlier in July, the Conservatives faced a significant political setback as his party was defeated in two parliamentary by-elections they would normally have expected to win. The Labour Party, which has been experiencing a resurgence, emerged victorious in Selby and Ainsty, a region in the north of England where the Conservative Party had previously held a strong majority. Additionally, the Liberal Democrats won the seat in Somerton and Frome, which was also previously held by the Conservative Party. While the Conservatives managed to retain a third seat in Uxbridge and South Ruislip, which was formerly held by former Prime Minister Boris Johnson until he resigned from parliament last month, Labour notably increased its share of the vote.

Overall, these by-election results indicate that Sunak's government is heading towards an electoral defeat in the next general election, expected to take place next year.

Tuesday, 1 August - TARGET balance statistics to be released  

On Tuesday, the ECB will release the latest data on the balances in its TARGET2 mechanism, incorporating data up until the end of June 2023. TARGET2 imbalances have been highlighted as indicative of a return to the malaise which engulfed the Eurozone in 2010/2011. 

Certain German commentators like to point to Italy’s TARGET 2 imbalances as evidence of danger to the German taxpayer.  Italy’s TARGET2 liability was €622 billion in May, although this was down from a record €714 billion in Q2 2022, its largest amount on record.  The Bundesbank surplus stood at €1.081 trillion in December.

However, rather than showing a financial crisis, the return of TARGET2 imbalances coincided with the ECB's asset purchase programme.  The frontloading of purchases under the ECB’s PEPP was reflected in TARGET2 data.  This is because 80% of all purchases under the ECB programme have involved counterparties located in a different country from the purchasing central bank. Furthermore, around 50% of purchases have involved sellers resident outside the euro area.  

As former ECB President Mario Draghi, noted in a July 2018 press conference:  

"Most of the movement in TARGET2 liabilities depends on our own asset purchase programme and depends on how and where – especially where – the balances of the purchases of bonds are settled. About 50% of the institutions….that sell bonds to the national central banks are not in the euro area and settle their account with one or two core countries where the financial centres reside". 

Indeed, ECB data shows that banks based outside the Eurozone tend to make payments in TARGET2 via branches or correspondent banks in countries with claims in TARGET2 such as Germany. As noted above, with 50% of purchases involving sellers resident outside the Eurozone, this is likely to alter the TARGET balance to increase Germany’s claims. Similarly, the higher TARGET liabilities incurred by the Bank of Spain and the Bank of Italy, reflect the fact that their respective purchases of Spanish and Italian debt are often from sellers that hold accounts in Germany. In any event, as the ECB is no longer purchasing any assets under its asset purchase programme, we should expect the Target2 imbalances to come down over the coming months.

Thursday, 3 August - Bank of England committee to decide on 14th interest rate hike

The Monetary Policy Committee (MPC) of the Bank of England (BoE) will meet on Thursday and is expected to increase interest rates for the 14th consecutive time as it continues to battle the highest inflation rate among G7 countries. Market participants are expecting the BoE to announce a rate increase of at least a quarter-percentage point to 5.25%.

On 22 June, the Bank announced its 13th consecutive rate hike to 5%, an increase from 4.5%, which was already the highest rate since 2008. The annual inflation rate slowed to 7.3% in June, down from 7.9% in May. Meanwhile, core inflation dropped from 6.5% in May to 6.4 in June 2023, raising market expectations that the UK rates will now peak below 6%.

UK Chancellor of the Exchequer, Jeremy Hunt has given interest rate hikes its full backing, stating they are “one of the most effective methods of bringing inflation down.” Meanwhile, the Governor of the Central Bank, Andrew Bailey has indicated that interest rate hikes may continue in the future, "it is crucial that we see the job through, meet our mandate to return inflation to its 2% target."

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