Last week, economic data for the UK presents a contrast, as headline inflation remains steady at 6.7%, defying expectations of a modest decrease. Meanwhile, wage growth has marginally slowed to 8.1% (including bonuses), offering some initial relief from the cost-of-living pressures.

Forecasts indicate a sharp drop in inflation in October, driven by reduced domestic energy costs. Simultaneously, the tightening labour market's grip is beginning to loosen. These factors reinforce the belief that the Bank of England has likely reached the peak of interest rates and is likely to maintain the current rates well into 2024. The latter half of next year is when interest rate cuts are anticipated as the focus shifts from combating inflation to stimulating economic growth.

In contrast, the US economy continues to exhibit strong performance, supported by better-than-expected retail sales data this week. This performance keeps the possibility of another rate hike by the Federal Reserve very real, as Treasury yields continue to rise. However, on account of a weakening economic outlook, aggressive rate cuts are now being factored in for the second half of 2024. The upcoming elections in the UK and US in the next year will add to the uncertainty and challenges faced by investors.

Looking ahead, the European Central Bank is scheduled to meet next week, but no changes in rates are expected, as they too are believed to have reached their peak rates. Forecasters predict that aggressive rate cuts are likely in the latter part of the following year.

Geopolitical tensions in the Middle East persist, contributing to a risk-averse sentiment in the market. Ongoing fears of an escalation in these tensions are keeping oil prices elevated and further fuelling inflationary pressures.

On the foreign exchange markets, the strength of the US dollar continues to gain momentum due to the country's economic outperformance and safe-haven investments. The GBP/USD pair remains volatile, trading above the critical 1.2000 level, while the GBP/EUR pair is at a 5-month low, trading below the pivotal 1.1500 level.

GBP is likely to face continued pressure against both the EUR and the USD, as recent data shows UK retail sales came in weaker than expected, and a significant drop in consumer confidence confirms the ongoing slowdown in the UK economy.

According to the Office for National Statistics (ONS), UK retail sales saw a 0.9% month-on-month decline in September, surpassing the market's anticipated -0.2% decrease and marking a sharp reversal from August's 0.4% growth. Year-on-year, retail sales for September are down by 1%, which is a slight improvement from August's -1.3% YoY figure but still falls short of the expected -0.1% contraction.

The initial reaction in the foreign exchange market was to sell GBP, reflecting investors' belief that the UK economy is poised to underperform both the U.S. and Eurozone economies. This data aligns with the notion that the Bank of England may maintain interest rates in November, potentially putting further downward pressure on GBP.

The GBP to EUR exchange rate is currently 0.86% lower, trading at 1.1455, and appears likely to break below its summer range, approaching levels not seen since May. The GBP to USD exchange rate is down by a quarter of a percent for the week, quoted at 1.2112.

The persistently high inflation in the UK is having a significant impact on consumer demand, leading to a steady decline in retail sales volumes since their peak in 2021. Despite declining sales volumes, the value of retail sales is still rising. Retailers have maintained their margins by increasing prices, but this has led to challenges in the sector's output.

Furthermore, the GfK consumer confidence survey for October showed a sharp decline, reflecting the increasing impact of the cost of living crisis and rising interest rates on consumers, which suggests a deteriorating economic outlook. The GfK Consumer Confidence Index dropped by nine points to -30 in October, with all five measures recording declines compared to the previous month.

According to Joe Staton, Client Strategy Director at GfK, "UK consumer confidence has fallen nine points this month to -30, taking us back to where we were in July this year. This sharp decline underscores the challenges posed by the cost-of-living crisis and the struggle to make ends meet."

GfK's survey indicates that "fierce headwinds" are affecting consumers as they grapple with heating costs, petrol prices, surging mortgage and rental rates, and a slowing job market. Uncertainties related to conflict in the Middle East are also contributing to this growing unease.

The outlook for retail sales remains bleak, as GfK's survey reveals a significant drop in its major purchase measure, down by 14 points, which is concerning for retailers as the holiday season approaches.

GBP appears to be facing renewed downward pressure against the EUR, following a brief seven-day recovery that was reversed toward the end of the previous week. The upcoming days are notable for the release of UK wage and inflation data, which is expected to generate interest and potential market movement.

On Tuesday, the focus will be on the release of UK labour market statistics. The market will closely react to earnings and changes in employment levels, as these indicators provide insights into the potential trajectory of UK inflation in the months ahead. Average Weekly Earnings (excluding bonuses) are projected to have increased by 7.8% on an annual basis, consistent with the previous month's figure.  The market anticipates a headline unemployment rate of 4.3% for August, unchanged from July but higher than May's 4.0% and the Bank of England's Q3 forecast of 4.1%.

Wednesday is set to bring the crucial inflation figures for September. Market expectations are for headline inflation to decrease to 6.5% year-on-year from the previous 6.7%. However, the month-on-month reading is expected to rise from 0.3% to 0.4%, primarily due to increasing fuel prices. A softer-than-expected reading could trigger a repeat of the September selloff, placing pressure on the lower end of range, and pressure at the 0.87p level GBP/EUR 1.1494.

Friday will see the release of GfK consumer confidence figures and retail sales. While these releases will be of interest, they are unlikely to exert a significant influence on the market, particularly in light of the substantial signals provided by the wage and inflation data just days earlier.

In the Eurozone, German sentiment will be scrutinized on Tuesday at 10:00 BST. Market participants will be keen to gauge the rating of Germany's prospects, especially given the recent downturn in economic activity, which has led economists at Deutsche Bank to predict the possibility of a double-dip recession.

On Wednesday, the Eurozone's inflation figures will receive final confirmation. As this is an update to the preliminary release, it is not expected to cause major market turbulence.

Recent indications suggest that the European Central Bank (ECB) is inclined to halt its interest rate hiking cycle. Governing Council members have emphasized the importance of Q1 2024 wage data for informing future policy decisions. This pause in interest rates is expected to limit the Euro's support through the interest rate channel, particularly when compared to currencies like the USD and GBP, whose central banks may consider further interest rate hikes in 2023.

Market analysts will also be closely monitoring geopolitical events in Israel. The recent eruption of violence in the region has prompted a shift in investor attention towards safe-haven assets.  Heightened geopolitical uncertainty typically leads to increased demand for assets like gold and the USD, while concurrently strengthening the appeal of US Treasuries, which have recently faced considerable selling pressure.

The market is currently factoring in the likelihood of another interest rate increase by the Bank of England in the upcoming months. This decision stems from their effort to manage persistently high inflation while also considering the potential risks of a recession. The economic data available is still quite mixed, and the overall economic outlook remains incredibly challenging. Factors such as the elevated oil prices and the weakening of the sterling are contributing to inflation, while the job market, a critical factor, continues to exhibit tight conditions.

Central banks, particularly the Federal Reserve, are maintaining their stance of keeping interest rates at higher levels for an extended period. This stance is significantly influencing market sentiment, with the possibility of another interest rate hike from the US central bank still on the table. The upcoming release of the latest US inflation data, scheduled for next week, remains a crucial factor in shaping interest rate policies.

In the Eurozone, it appears that interest rates may have reached their peak, with expectations of rate cuts being factored in for the latter half of 2024. This projection is due to the gloomy growth outlook and the real possibility of a recession in the region.

The strength of the USD continues to play a pivotal role in determining interest rate policies. This is driven by the US economy's strong performance and the prevailing risk-averse sentiment in the market. Additionally, ongoing weaknesses in China are further exacerbating these dynamics. The GBP/USD pair has dipped to new six-month lows, falling below the 1.2200 level, while the GBP/EUR pair has dropped to a two-month low of 1.1500, where initial signs of demand are starting to emerge.

Main UK data point this week is the GDP release on Thursday.   In July 2023, the UK economy experienced its most significant monthly contraction of the year, declining by 0.5% compared to the previous month. This contraction exceeded the consensus expectations, which had predicted a milder decline of -0.2%. The unexpectedly sharp decline was attributed, in part, to adverse weather conditions and industrial strikes.

In the current month, market analysts anticipate a 0.1% month-on-month contraction in GDP. This projection takes into account the impact of elevated interest rates and rising living costs, both of which are putting pressure on consumer demand.

Market participants will also be tracking geopolitical developments in Israel.  The outbreak of violence in Israel over the weekend has led investors to shift their focus towards safe-haven assets, increased geopolitical uncertainty tends to drive up demand for assets such as gold and the US dollar, while simultaneously bolstering interest in US Treasuries, which have recently experienced significant selling pressure.