- Rates raised to the highest level for almost fifteen years
- IMF warns about debt ceiling debacle
- Pessimism over inflation growing
Bailey sees inflation being higher for longer
At his press conference, Bailey made no mention of any pause in rate hikes despite them coming close to being restrictive on demand. Bailey went on to say that food inflation which is currently around 19.5% has peaked, although it will take some time for it to fall to “more acceptable levels”.
Overall, inflation remains at close to forty-year highs and is only slowly beginning to fall despite the decline in energy prices. Food prices remain a significant concern for the Central Bank, as he was questioned about the reason why falls in global wholesale prices of food items haven’t led to a drop in front-line prices in supermarkets.
Apparently, there is between a three and nine-month lag between wholesale prices falling and retail prices following suit.
Two Cabinet Ministers yesterday agreed that the fall in the workforce of close to 400k since the pandemic is not allowing the Government to cut taxes. Unless this situation is reversed, the government, whoever wins the 2025 General Election, may be forced to increase the retirement age to 68 in order to plug the gap that has been created by the loss of tax receipts.
The Bank of England is more akin to the ECB than the Federal Reserve in not making any promises about when the seemingly endless stream of rate hikes will end. The U.S. is possibly more self-sufficient in food production while both the UK and Eurozone have been badly affected by the war in Ukraine.
The country’s “growth engine” appears to have spluttered into life as the economy moves further away from a recession which late last year appeared to be a certainty.
However, the longer the Bank of England persists with rate hikes to battle inflation, the likelihood grows that small and medium-sized businesses will be put off investing in new plants and machinery as the cost of working capital facilities granted to them by their banks becomes prohibitive.
Sterling continues to gain strength overall from the series of rate hikes, although it saw a correction yesterday, falling to a low of 1.2496 and closing at 1.2511 in the wake of the Bank of England’s decision on rates.
It is close to a tipping point where the benefit of rate hikes is offset by concerns about their effect on demand.
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Powell’s approval rating continues to fall
While it is true that he made a significant gaffe in calling rising inflation transitory in mid-2021, he has not received the credit he should have for steering the economy through the turbulence of the Pandemic.
Now, as the economy apparently teeters on the brink of a recession, his calls over interest rates are drawing criticism from the markets.
The past three or four employment reports have made doing anything other than hiking rates an almost impossible task. The possibility remains that Powell will engineer a soft landing for the economy where inflation returns to its target of 2% this year while the creation of new jobs falls back into line without turning negative.
So far the economy is seeing a number of scares, mostly from the CEOs of major banks and financial institutions, concerned that three banks have collapsed citing high interest rates as at least part of the cause.
Powell, clearly chastened by his “transitory” gaffe, is determined to see his personal goal of bringing inflation back into line fulfilled even if he is playing with fire as far as economic growth is concerned.
Data released yesterday showed that wholesale prices rose modestly last month. This is a sign that inflationary pressures are beginning to ease.
Weekly jobless claims continue to rise which is an indicator of a slowdown in employment, which perversely will be welcomed by the Fed. New claims reached an eighteen-month high of 264k last week with the four-week average reaching close to a quarter of a million.
Today sees the release of the University of Michigan survey of consumer sentiment. This has taken on a greater significance of late as consumers are considered a vital part of continued high demand. The index is expected to fall marginally from 63.5 to 63 as concerns over higher interest rates on overdrafts and credit cards begin to bite.
Yesterday the dollar index moved away from its support as it reached its highest level this month. It reached a high of 102.14 and closed at 102.08.
Rate hikes to reach restrictive, while inflation fails to fall
Several members voiced their concerns when, following a major review of ECB operations, Christine Lagarde announced a subtle change in the Central Bank’s target for inflation, changing it from a 2% to an average of 2%.
The hawks believe that this allowed the ECB to be too lenient on prices as they had been well below 2% for several months. This resulted in no action being taken as inflation took hold, which coincided with the energy supply crisis and the war in Ukraine.
The overall result was that the Central Bank was “late to the party” when it came to interest rate hikes which has led to them likely raising rates well into the third quarter of the year if not longer.
The makeup of the economies of the twenty members of the Eurozone means that rates are unlikely to become restrictive on demand at the same time.
This means that some countries will experience a significant slowdown, and possibly a recession, while others still see minimal growth.
A month or two ago there was increasing confidence that the entire economy would escape, despite some members, notably Germany, experiencing a technical recession.
That view has gradually changed, following Christine Lagarde’s comments following the latest ECB meeting, where she was clear that further work needs to be done to bring inflation back to its target.
This was interpreted as a warning that further rate hike could be expected and was further exacerbated by the support she received from several members of the Council.
It may be another couple of months and a couple of further rate hikes until rates reach restrictive territory, during which time the market will fret about a full-blown recession across the entire region.
Yesterday, the single currency corrected as it became clear that the effort of trying to break through the mass of sellers above the 1.10 level was too much.
It fell to a low of 1.0900, its lowest since early April, and closed at 1.0915.
Have a great day!
Exchange rate movements:
11 May - 12 May 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.