10 July 2023: Bailey plays down Brexit as a factor in inflationary pressures

10 July 2023: Bailey plays down Brexit as a factor in inflationary pressures


  • No tax cuts before the election
  • The job market is cooling but remains strong
  • Lagarde wants rate to continue rising to ward off wage/price spiral
GBP – Market Commentary

BoE Governor disagrees with his predecessor

The Government, already a considerable distance behind in opinion polls, has decided that it won’t try to “bribe” the electorate by cutting taxes in the run-up to the General election that has to take place before January 2025.

The Chancellor of the Exchequer, Jeremy Hunt, has admitted that the current economic conditions in the country make any pre-election cuts in his Autumn statement “unlikely.”

Following Rishi Sunak’s pledge to halve the rate of inflation by the end of the year to around 5%, Hunt will not add billions to demand while the Bank of England is tightening monetary policy to reduce it.

Hunt has already said that achieving the Cabinet pledge on inflation will be difficult to achieve.

The Conservative Party, which has appeared to be on the brink of civil war constantly since David Cameron’s departure as Prime Minister seven years ago, will need to use the summer recess of Parliament to regroup and try to find a way to eat into Labour’s lead in the polls.

In the past, the Tories have often benefitted from several “banana skin moments” that have befallen the Labour Party, but while the electorate remains concerned about the undue influence exerted by the trades union movement on Labour policy, they are clearly in the mood for a change, given the turmoil created most recently by Liz Truss and Boris Johnson.

Hunt and Sunak still face the twin issues of public sector pay and the current state of the NHS, which having just celebrated its 75th anniversary, is, on the surface at least, facing collapse.

It is understood that a public sector pay review that was recently undertaken by the independent review board has recommended an across-the-board increase of 6%. If this were granted, it would make achieving the Government’s inflation goal impossible, without significant austerity measures being introduced. These would prove unpopular with voters and would virtually concede the election.

There are two opposite opinions about the economy currently. The IMF has said that the Government is “on the right track” and should continue with its current policies, which will avoid a recession and lead to falling inflation and increased prosperity eventually.

However, several economists from financial institutions and think tanks believe that the continued raising of interest rates by the Bank of England will lead the economy into a contraction in the final quarter of the year and provoke a period of stagflation.

The clock is ticking on Rishi Sunak’s time as Prime Minister, and his party faces an extended period in opposition unless there is a radical change in its fortunes.

Last week, Sterling traded close to the medium-term resistance level that has capped it for the past four weeks. It reached a high of 1.2849 and closed at 1.2839.

USD – Market Commentary

The Chicago Fed President sees no reason the economy cannot achieve a soft landing

The June employment report, which was published on Friday, showed that the number of new jobs created was lower than expected, although the jobs market remains strong.

The headline non-farm payrolls showed that 209k new jobs were created, against predictions of around 240k-250k. The unemployment rate fell from 3.7% to 3.6%.

In the past, an unemployment rate of below 5% was close to full employment. This is one of the major structural long-term changes that have taken place in the economy that have led to increased inflation and higher interest rates.

The employment to population ratio, the figure the World Bank considers to be an important indicator of how efficiently the economy creates jobs for those who want to work, is at its highest level for more than twenty years.

Over the last quarter, there were substantial increases in public sector employment across Federal, State and Local Governments.

This is a considerable improvement in a sector that was slow to recover from the Pandemic.

Several members of the FOMC were quick to comment on the data and its effect on the rate decision, which will be taken in a little over two weeks.

The Chicago Fed President, Austan Goolsbee, believes that inflation can be tamed without a recession since rate increases going forward can be moderate in both size and frequency. However, it is the view of the market that the current bout of credit contraction will see a mild technical recession towards the end of the year, even as more jobs are added.

Goolsbee’s colleague at the Dallas Fed believes that more rate hikes will be necessary to defeat inflation and, more importantly, prevent its return. Lorie Logan believes that there is a compelling case for a hike at July’s meeting, which the continued strength of the employment data has confirmed.

She believes that it is imperative that the FOMC follows through on its commitment to tame inflation, and she estimates that at least two-thirds of the committee is in favour of a hike at the next meeting.

Last week, the dollar index found support at around the 102.20/30 level that has been in place since the last FOMC meeting. It tested and failed to break that level, although it continues to lack any significant drivers to return to its highs from earlier in the year.

The probable diversity of monetary policy between the U.S. and other G7 members will keep it at or close to this level in the medium term.

EUR – Market Commentary

The French Central Bank Governor argues against the raising of the inflation target

Last week, the Governor of the Bank of Italy proposed that the ECB should consider halting the cycle of interest rate hikes and replace them with a commitment to keep rates at their current elevated level for as long as is necessary to defeat inflation. This idea received a lukewarm recession from the German Chancellor and the country’s Central Bank President, who both called for a further hike at this month’s meetings and “serious consideration” to be given further hikes after the “August break.”

The President of the Banque de France also confirmed that he will vote for a hike at the next meeting of the ECB’s Governing Council but was more positive about the end of the cycle of rate increases.

He agreed with Ignazio Visco, his Italian counterpart, that rates are close to a plateau, although he didn’t say how long that should stay at or close to their current rate, since the economy is beginning to falter.

Francois Villeroy de Galhau dismissed “out of hand calls for the ECB to consider raising its inflation target. The target has been labelled “outmoded” and “unattainable” in the post-Pandemic world. The former Chief Economist at the IMF, Olivier Blanchard, spoke recently of his belief that the 2% target for inflation that is shared by the entire G7 except Japan, should be raised, or scrapped entirely since the increased flexibility it would provide would far outweigh the costs.

The French Finance Minister, Bruno Le Maire, spoke at a conference on Saturday of his agreement that economists should have “full and frank” discussions about making the economy more efficient and that no topic should be considered “taboo.”

De Galhau disagreed vehemently, commenting that “moving the goalposts” would be a cosmetic change, and would lead to higher rather than lower borrowing costs.

Christine Lagarde continued her mantra about higher interest rates in a speech last week. She believes that tighter monetary policy is vital to ward off the threat of a wage/price spiral, evidence of which is beginning to manifest itself in the latest data.

Last week, the common currency gained on the back of further expected rate hikes. It also ran into medium-term resistance and ran out of steam. It reached a high of 1.0973 and closed at 1.0966. It does appear to be “gearing itself up” for another attempt at the 1.10 level, but there is a great amount of selling interest above that level which it will do well to get past.

Have a great day!

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Alan Hill

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.