- Q4 GDP data to confirm concerns over a recession
- Fed Governor Waller sees interest rates exceeding expectations
- German inflation turns higher again
Continued high inflation is damaging confidence in BoE
With headline inflation still well into double figures, some committee members accused Bailey and the MPC of damaging confidence in the Central Bank.
While providing his half-yearly testimony before Parliament, Bailey was asked how he can expect the public to be confident that the right decisions have been made over the past eighteen months given the continued high level of inflation in the economy.
Bailey clashed with committee chairman Harriet Baldwin over the Bank’s delay in raising interest rates until the furlough scheme had come to an end. Inflation has remained above the Bank’s 2% target every month since December 2021.
Bailey countered by commenting that since the scheme was considered vital to drive the economy forward as the country was emerging from the Pandemic and was inflationary by its very nature, inflicting higher interest rates on borrowers would have been counterproductive in the MPC’s opinion.
He predicted that by year-end, inflation would have fallen to 5%. The unwinding of base effects will be a major cause of lower inflation. These are the effects of previous years price increases on current inflation.
Baldwin was openly critical of the Bank’s record of forecasting inflation, given how often those forecasts are proven to be incorrect. Bailey answered that it is impossible for forecasts to be guaranteed as correct, given the large number of moving parts that go into making assumptions.
The role of the Bank of England is not to let inflation rise to unprecedented levels and only then try to bring it under control. Parliament has a right to expect the Central bank to be sufficiently aware of the ramifications of events to be able to counter them. In response, Bailey said that the Bank doesn’t have the benefit of hindsight when making assumptions.
Today sees the release of Q4 GDP data. It is expected that the economy contracted by was flat in the period between October and December, meaning that a recession hasn’t started. With confidence growing that some growth will be seen in the second quarter, given that the current quarter has basically already been written off, the UK may escape a technical recession by the skin of its teeth.
Sterling has had a fairly strong week overall, but that could all change if the GDP data disappoints.
Yesterday, it rose to a high of 1.2193, but fell back to close at 1.2116.
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This has led to him attracting criticism over his over-analytical personality.
The market will forgive a Central Bank that is nor always right in its assumptions,but will always expect to be kept informed of its intentions.
There is little doubt that Powell has had a rough ride during his tenure as Chairman, given the monetary policy difficulties created initially by the Pandemic and followed by raging inflation which came close to getting out of hand.
He will have learned that it is unwise to make off the cuff, possibly glib comments since these may come back to bite you. In the current environment, it is undoubtedly tough to manage the Central Bank under a Democrat Administration.
Although it is doubtful that Powell would wish to see the return of the Trump era, the job of the FOMC is made harder by the social awareness of the Biden Presidency. The way the U.S. economy functions is to ensure that big business feels confident that the Central Bank has its interests at heart.
Under the Democrats, far greater emphasis is placed upon the individual when led to a level of support during the pandemic, which is still being paid for with inflation that remains uncomfortably high. Interest rate hikes may continue past the end of the current quarter, although the word on the street is that two further hikes may be sufficient to bring down demand.
Data for consumer confidence will be published later today, and it is expected to rise for the fifth consecutive month, although the size of the increase is likely to be smaller than it has been of late.
The dollar index appears to be unable to break through resistance round the 104 level. Yesterday, it reached a high of 103.56 but ran into selling pressure which saw it close at 103.21.
Next week will see the release of inflation data for January. It is predicted that the headline figure will have declined to 5.3% from 5.7% in December. This will lead to calls for a fifty basis point hike in March, since prices are still not falling quickly enough for the market’s liking.
Banks pressured to end Russian exposure soon
For this reason, Brussels is putting a significant level of pressure on banks to, as far as possible, exposure to Russia, in particular state owned businesses.
Although Russia has had problems with access to foreign currency, it faces two immediate issues that have worsened significantly since it invaded Ukraine.
The first is the fall in oil and gas revenues, due in no small part to the efforts of European Union states to wean themselves off the overdependence on Russian energy. The second is the prediction of Vladimir Putin to try to weaponize every part of the Russian economy.
He would think nothing of banning state-owned enterprises from repeating debts that have been built up to foreign investors. Any such move would be disastrous for Eurozone banks, given the highly profitable trade related operations they still have in the country.
Despite the high level of inflation and the ECB’s efforts to try to contain it, the economy is beginning to gain traction due in no small part to the relatively mild winter that has been seen so far which reduces the overreliance on imported energy.
Almost as important has been the level of confidence that is beginning to be seen in the economy as the green shoots of a recovery are beginning.
Russia has not attempted any retaliation over the German decision to provide Ukraine with battlefield tanks to combat Russian aggression, and it may well be that something is planned to coincide with a probable Spring offensive.
Until there is a glimmer of hope that hostilities will end in the short or medium term, the Eurozone will continue to live under the shadow of further Russian driven economic uncertainty.
Next week will see data from Germany on inflation as well as Eurozone industrial production. Both are expected to show some improvement.
The euro is holding its own versus the dollar, and the wide 1.00 to 1.10 range is likely to remain in place for some considerable time. Certainly, until the monetary policy situation has seen some degree of resolution. The euro is supported by the notion that the ECB will continue to hike rates after the Fed has signalled a pause.
Yesterday, the euro, which has had a mixed week, rose to a high of 1.0790 and closed at 1.0733.
Have a great day!
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09 Feb - 10 Feb 2023
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Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.