ECB on pause, UK growth stalls, and markets look to the Fed

After a strong start to the summer, markets are entering September with a familiar mix of optimism and uncertainty. Inflation dynamics, shifting central bank policy, and political instability continue to set the tone, and for UK investors, the interplay between these global forces and the domestic economy is particularly relevant.

This week we look at the latest data from the UK, Europe’s rate backdrop, and the US Federal Reserve’s highly anticipated September meeting.

UK - Growth sputters as manufacturing falters

The UK economy flatlined in July, following 0.4% growth in June. Services and construction made modest gains, but a 1.3% contraction in manufacturing pulled the overall figure down. That leaves the rolling three-month growth rate at just 0.2%.

For households and investors alike, the picture is of an economy stuck in low gear. Inflation has eased considerably over the past year, but higher borrowing costs and subdued business investment continue to bite. Attention now turns to November’s budget, where the government faces a difficult balance: deliver fiscal consolidation to reassure markets, while trying to support growth ahead of local elections in the spring.

Sterling remains range-bound against the dollar, supported by broad US weakness but looking vulnerable against the euro. UK equities, meanwhile, continue to trade at a discount to global peers - attractive on valuation grounds, but with muted earnings momentum.

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Europe - ECB holds steady, outlook finely balanced

The European Central Bank kept its key deposit rate unchanged at 2% last week, as expected. President Christine Lagarde struck an upbeat tone, noting that inflation is “in a good place” at 2%, and the Bank nudged up its growth forecast for this year to 1.2%. However, the outlook further out is less encouraging, with 2026 growth expectations revised lower.

Markets interpreted the ECB’s message as signalling the end of its rate-cutting cycle. But some strategists argue there may still be room for one more reduction if trade tariffs, French political risk, or a stronger euro tighten financial conditions further.

Germany remains the bellwether. Exports fell 0.6% in July, led by a steep drop in US demand, while industrial output surprised on the upside. The mixed data underscore the challenges facing Europe’s largest economy as it navigates global trade headwinds.

Political uncertainty in France also lingers. President Macron’s appointment of Sébastien Lecornu as prime minister follows the collapse of the previous government over a debt-reduction budget. Investors are watching closely: French bond spreads have widened to their highest since late 2024, reminding markets that fiscal credibility matters.

United States - Eyes on the Fed, with AI as the sideshow

Across the Atlantic, all eyes are on the Federal Reserve’s September 16–17 meeting. Markets are pricing in a widely expected rate cut, despite consumer price inflation edging up to 2.9% in August. Core inflation remains at 3.1%, still above target but not enough to derail the Fed’s easing path given a softer labour market.

The latest jobs data have been weak, with jobless claims hitting their highest since 2021 and prior payroll figures revised down sharply. Consumer sentiment has also dipped, reflecting rising concerns about business conditions and inflation persistence.

Equity markets, however, have been buoyant. The S&P 500, Dow Jones and Nasdaq all reached record highs last week, helped by enthusiasm around artificial intelligence. Oracle’s upgraded revenue guidance, citing major new AI contracts, fuelled renewed optimism in the sector. Yet beneath the surface, the rally is heavily concentrated, and valuations remain stretched.

Long-dated US Treasuries have rallied, with yields easing on the back of softer economic data and strong demand at auctions. That has supported credit markets too, with both investment-grade and high-yield bonds advancing.

What It Means for You

For UK private investors, three key themes stand out this week:

1. The UK economy remains fragile. Valuations are supportive, but growth momentum is weak. Selectivity in equities and an eye on sterling’s performance against the euro are important.

2. Europe’s rate path may not be finished. The ECB may hold steady for now, but risks from trade, politics and currency strength could bring further easing. Cyclical European sectors still offer opportunities, but political risk must be monitored.

3. The Fed dominates global markets. A widely anticipated rate cut could support both bonds and equities, but stretched valuations, particularly in US tech, argue for caution.

In short, while central banks have provided a floor under markets, earnings and politics are doing the heavy lifting in driving sentiment. Staying globally diversified, with balanced exposure to equities and fixed income, remains the most resilient approach.