10 June 2022: High growth, low inflation on the way

High growth, low inflation on the way

10th June: Highlights

  • Johnson performs, yet another, reset
  • Fuel costs affecting every area of the economy
  • Negative rate era ending, but hawks may still be disappointed

GBP – Prime Minister promises a home owning economy

Prime Minister Boris Johnson has emerged from yet another near-catastrophe wounded but not yet mortally and has regurgitated a former vote winning policy in an effort to relight voter confidence in his Government.

Having survived a vote of confidence in which 148 of his MPs polled in favour of him being removed from office, it now seems to be a long way back.

As the economy begins to slow into what looks like stagnation, Johnson faces a major job to repair the damage of Brexit and the Pandemic while also trying to repair his own scandal hit reputation.

He will be unsure of the support of his senior colleagues who may see him as a useful stopgap while the economy goes through a cost of living crisis that may well worsen before any recovery begins.

There is an air of MPs biding their time, allowing Johnson even more rope to hang himself, in the knowledge that he will surely oblige.

Right to buy was both a huge vote winner in the Thatcher years, as well as a tragedy for the social fabric of the country.

While Local authorities were allowed to sell off their stock of social housing, they were either not required to replace that stock or managed to avoid doing so.

This led to the shortage of low-cost rental properties owned by Councils and Housing Associations a generation later.

The return of the scheme introduced yesterday has two significant changes: First, there is a pledge that the stock will be replaced one for one, and second, those people on the Universal Credit benefit will be allowed to use their benefit to pay off mortgages.

This second pledge will be a vote winner. In the past only rent could be eligible for the housing part of UC now it will also support mortgage payments.. This will ease the burden considerably if the economy worsens and unemployment begins to rise significantly.

The leader of the Opposition derided the announcement as the reintroduction of a failed policy illustrating how the Government has run out of ideas.

With the price of fuel on garage forecourts hitting two pound a litre, there are calls for the Government to introduce a windfall tax on its own fuel duty. With just under 50% of the cost of a litre being made up of tax and duty, the Government has seen its income balloon. The fuel industry believes that a cap, similar to the household energy cap would work in bringing down the price of petrol and diesel to more acceptable levels while providing relief to hard-hit drivers, both domestic and commercial.

The pound remained in its recent range yesterday, losing a small amount of ground to a slightly stronger dollar.

It fell to a low of 1.2487, closing at 1.2493.

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USD – The recession, no recession debate now on Party Lines

Economists’ opinions, and the variety thereof, are part of the lifeblood of the financial markets. They divide opinion which drives markets and their independence is a cornerstone of volatility.

There is a growing body of evidence that economists at several New York Financial Institutions are becoming more politically driven in the aftermath of the wild west time of the Trump era.

It is believed that efforts are being made to bend opinion by predicting that the country will suffer a recession which is more significant than is currently being predicted if the Democrats are able to survive the midterm elections that will take place in December.

Of course, every economist can justify his or her opinion with data, but at the end of the day, this community survives on accuracy of prediction, and on this hangs their reputation.

At the current time, the overall view is that while the country is likely to come very close to a recession, when measured by the time-honoured way, of two consecutive quarters of economic contraction, and may even fall technically into a recession, the economy is such and the determination of the Administration, in particular of the Treasury and Central bank, all efforts will be made to ensure such an event is very brief.

While next month’s FOMC meeting is being considered something of a non-event given the volume of advance guidance that has been provided, this has often proved to be a dangerous attitude in the past, today’s release of inflation data could be an event that shakes the market back into life.

It is expected that headline inflation will fall very slightly, leading to many commentators calling the top, but were it to continue to rise, the hawks on the FOMC may begin to call for more action, probably in the shape of an increase in the level of bond sales that are being initiated to bring down the size of the Central bank’s balance sheet. These currently stand at ninety billion dollars a month.

Jerome Powell has mentioned the possibility of a seventy-five-basis point hike in the past but has dismissed it as unlikely to be necessary.

The dollar index remains in the doldrums. Yesterday, it rose within its current range, reaching a high of 103.36, closing at 103.30. Although it remains within its recent range, this was its highest close since May 19th.

EUR – The question remains, after so long, what is normal?

The cat is out of the bag!

It was never much of a secret that the ECB was going to end the support it has been providing to the ailing Eurozone economy, at its rate setting meeting that took place yesterday, but provided a little drama to a market that has been languishing.

Yesterday’s meeting confirmed the end of bond purchases and that it will allow current stocks to run off without them being replaced.

It is a case of out of the frying pan and into the fire, for several Eurozone members, as they will immediately face the prospect of finding buyers in the market for their paper, undoubtedly paying a significant premium over their recent cost for doing so.

This may be a significantly more onerous task than they expect as their economies begin to contract and the war in Ukraine goes on, adding to the risk of it spilling over, however remote that may be.

The ECB has committed itself to initially raising interest rates twice in the next three months, but even that may disappoint its more hawkish members.

There is no indication that the hike will be any more than the twenty-five basis points that had been predicted for several months. That is, until recently.

There were suggestions from several quarters that a fifty-basis point hike may be considered, at least initially, to show the Central Bank’s intentions to make serious efforts to rein in inflation which continues to rise.

ECB President Christine Lagarde hinted at the possibility that the Bank may consider hiking by fifty basis points in September, if the situation warrants it, although it will start with twenty-five next month.

This came as no surprise to the market, and neither did the reaction.

The euro began what may be the start of its long-awaited descent as the divergence between interest rates in the Eurozone and United States continues to widen.

Yesterday, the euro fell to a low of 1.0611 and closed at 1.0617.

Have a great day!
About 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.”