Economy slowing significantly
Morning mid-market rates – The majors
12th April: Highlights
- Manufacturing and Industrial out fall into negative territory in February
- Odds on a recession are a coin toss
- Even the lowest inflation rate in the Eurozone is twice the target
GDP was just about positive in February
Industrial activity fell by -0.6% from 0.7% in February, while manufacturing fell to -0.4% from 0.9%. Year-on-year, industrial production halved to 1.6% from 3%, while manufacturing fell from 52.3% to 3.6%.
While these falls were anticipated and these sectors make up just 20% of total GDP, it is indicative of how the economy is slowing as the headwinds that have been forecast take effect. This sets the start of a trend that will accelerate when increases in the cost of energy and tax payment are factored in.
The data intensifies concerns about the cost-of-living squeeze. Overall, GDP rose by just 0.1% in February, versus market expectations of a 0.4% rise.
The NIESR estimate for GDP in the three months to March was 1%. This is in line with market expectations and illustrates how the economy is slowing even before the rise in the energy cap and the cost of fuel is factored in.
Q2 is going to be particularly tough for the average family as rising inflation eats into available income.
Coronavirus remains an issue as the availability of free testing is winding down and this is leading to a surge in cases. The NHS is under severe pressure to deal with backlogs of patients waiting for non-essential surgeries.
Questions are being asked in Parliament about the effectiveness of the Chancellors increase in National Insurance increase when compared to the burden it is adding to working family’s outgoings.
One of the major contributors to the downturn in manufacturing and industrial output is the vehicle industry.
New car registrations in March fell to their lowest level since 1998. This marked a 14% fall.
As expected, one of the major growth areas was tourism, as restrictions of travel and holiday bookings soared by 33%.
Despite the gloomy outlook, the economy is now 1.3% above its pre-Covid level. The economy lost momentum during the first quarter as the country emerged from the Pandemic. While getting back above its pre-Covid level is important, it could easily fall back to that in Q2 if output continues to falter.
The pound was not too badly affected by the weaker than expected data. It remained above that week’s closing level all day, managing to climb to 1.3056 before settling back to close marginally higher on the day at 1.3030.
The March employment report will be released this morning. It is expected to see the unemployment rate unchanged at 3.9% in what could be the final positive for jobs in the current cycle.
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Inflation headline set to break 8%
While both actions are entirely justifiable given the high (and rising) level of inflation, there are hawks who see the need for a more significant hike while others scream recession!
Calls for a 100-basis point hike are justified by the question; if fifty basis points will slow rising inflation, why not raise by a hundred and then study the effect?
The jury is out on whether the country is facing a recession if the FOMC acts in accordance with the advance guidance that has been provided by Jerome Powell.
A few prominent economists believe that the economy is on a knife-edge and the prospect of a recession is close to fifty-fifty.
It is hard to look too far into the future, as the FOMC is determined to act in accordance with the data. While proactivity may be sensible, it brings back into play fears of the Central bank falling behind the curve, as it clearly did last Autumn.
The misjudgement of the pace at which inflation would rise and the factors driving it is unlikely to be repeated, but the U.S. financial markets expect the Fed to be both intuitive and aggressive. With that stance comes the issue of occasionally making a wrong call.
Cruising inflation has sent longer term interest rates far higher, with the thirty-year mortgage rate above 5%. That means it has doubled in a little over a year.
Today will see the release of the inflation data for March. It is expected that the headline rate will have risen from 7.9% in February to 8.5% in March. The core figure with food and energy stripped out is also expected to have risen, from 6.4% to 6.6%.
This clearly demonstrates the nature of inflation and the effect of the significant rise in fuel prices in the past couple of months.
The dollar index is still toying with the 100 level. Yesterday, it reached a high of 100.05, closing at 99.97. This capped an eight-day run of higher closes. If the inflation data points to the FOMC having to be even more aggressive, we may see a conclusive break of the 100 level.
Back to the issue of one size fits all
On the one hand this shows that, despite inflation being close to double the ECB’s target in Malta, due almost entirely to the cost of fuel, an interest rate hike is barely justifiable, while in Lithuania, far more severe measures are warranted.
It is fairly obvious, given the volatility of energy prices and the knock-on effect of the conflict in Ukraine, that the divergence in both the inflation rate and the level of output being seen, varies wildly.
There has never been a more obvious illustration of how the one-size-fits-all policy of the ECB dominates the entire Eurozone. It also shows that whatever happens at this week’s ECB meeting, some counties will see their economies slowed by any rate hike or other monetary policy measure, while others will barely see a scratch to their rate of inflation.
The follow-up question is therefore; how does the Central bank decide whose case is the strongest?
There have been veiled comments from ECB members, not least of all its Chief Economist Philip Lane, about the possible creation of new tools to assist the Central Bank in maintaining an equitable monetary policy. There must be some head-scratching going on, not least of all in Valletta and Vilnius, about the point of monetary union.
In February, three nations, all in Eastern Europe. have inflation rates above 10% while Belgium has the highest rate of the established members, at 9.5%. Seventeen nations have inflation above the average, with ten below. Italy was the single nation whose inflation rate was at the average rate.
Whatever the new tools are, they will need to be effective without creating any form of arbitrage opportunity for the market.
The euro will have one further driver to contend with over the next couple of weeks. The election in France is expected to be a close-run thing, in contrast with the last time, when Macron and Le Pen were the last candidates standing.
While Macron remains favourite to win, any advances made by Le Pen will see the euro under pressure, given her nationalist policies that could eventually see Frexit return to the table.
Yesterday, the euro managed a brief rally but fell back to close almost unchanged. It reached a high of 1.0933, but fell back to close at 1.0833
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.”