13 July 2021: Bailey remains relaxed about data

Bailey remains relaxed about data

13th July: Highlights

  • Like for Like Retail Sales disappoint
  • Hyper hypersensitivity driving dollar
  • Lagarde gives advance warning of policy shift at next meeting

Inflation expected to remain above 2% for the foreseeable

Andrew Bailey, the Bank of England Governor, remains relaxed about the prospect of inflation remaining above the Government’s 2% target for the foreseeable future.

Central banks in the developed world have all adopted a less proactive attitude to monetary policy, given the unpredictability of the recovery and how the withdrawal of various forms of support will affect growth and activity.

In the UK, the gradual withdrawal of various Government initiatives will bring unknown consequences, in particular to the property and employment markets.

For this reason, Bailey has to allow inflation to rise beyond its target level in order to be in a position to be flexible, leaving support in place if the economy dips, or beginning to taper if Monday’s complete reopening drives inflation to levels which are considered to be unmanageable.

So far, the level of demand which is outstripping supply has been a significant driver of price rises but as the rest of the economy reopens, it is likely that this phenomenon will fade.

Boris Johnson finds himself caught between two stools regarding the withdrawal of restrictions. On the one hand, the rate of infections has risen as the medical community acknowledges the country is now in the grips of a third wave, but while hospitalizations, especially amongst the young, are rising, their length of stay is far shorter and unlikely to put undue stress on the NHS.

In confirming the removal of all remaining restrictions, Johnson called for a cautious approach from the public.

While removing the requirement for face coverings to be worn on, for example, public transport, he also called for a sensible and realistic approach as he warned that the Pandemic is not yet at an end.

The economy continues to perform well, although data for like for like retail sales that was released overnight was a significant disappointment. Expected to rise by around 25% after an 18.5% increase last month, the rise was only 6.7%.

The FX market continues to be unsure about its future direction. Major currencies are in a relatively narrow range, with any significant change of direction firmly in the hands of Central Banks.

Yesterday, the pound found progress above the 1.39 level versus the dollar difficult, with its close at almost the same level, 1.3886, as on Friday. It has also found the same level of resistance so far overnight.

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Risk appetite under wraps

If pressed, traders and investors will say they expect the dollar index to rally towards the high 93’s over following the summer, but none are willing, yet, to put their money where their mouth is.

That feeling is entirely driven by a view that the Fed will be the first Central bank to taper its support for the economy by beginning to reduce its level of bond purchases.

While this is a reasonable assumption, given the level of proactivity seen by Jerome Powell and his FOMC colleagues at the start of the Pandemic it is by no means certain.

When the Pandemic began, the Fed was very fast to act, and Powell believes that monetary policy is best when left to garner its full effect.

New York Federal Reserve President John Williams sounded a note of caution yesterday when he commented that the economy has not yet achieved the level of substantial progress needed for the gradual withdrawal of asset purchases to begin.

If that sentiment is echoed by his regional colleagues, then the Fed could easily slip behind in the race to taper.

The Central bank has been purchasing both mortgage-backed securities and Treasury Bonds, but Williams was at pains to say that the effect on the economy is roughly the same for each class and there is no focus on the housing market, which has rallied strongly.

The corporate earnings season is about to begin in the U.S., and it may be difficult for businesses in certain areas of the economy to justify their market valuations. The time has long passed when the valuations of the likes of Google and Facebook bear any relation to current earnings, but that rule still applies to the market in general.

The dollar continues to struggle to break higher, and the 92.80 level has now become very strong resistance.

Yesterday, the index again rallied, but reached only 92.41 before running out of steam and closing at 92.23.

Market primed for information at next week’s ECB meet

ECB President Christine Lagarde took full advantage of the Bank’s hold over the financial markets by whetting analysts’ appetite for news with a comment yesterday that there may be a significant change of policy at next week’s meeting of the General Council.

She predicted a policy shift at the July meeting, which takes place next Thursday.

She went on to say that fresh measures are likely to be brought in next year to support the Eurozone economy once the current bond purchasing agreement ends. This is expected to take place next March.

Having recently adjusted its inflation target, next week’s meeting, which the market had expected to be daily mundane and simply be a repeat of previous non-events, will now hold the market’s attention.

Lagarde promised some interesting variations and changes. The nature of these will provide the market with ten days of speculation while it still digests the slightly more dovish move from the Bank over inflation.

The ECB President went on to speak in more general terms, commenting that she is still only guardedly optimistic about the recovery of the economy. She remains cautious about providing any guidance which leads the market to believe that the support will end in the next few weeks of months.

Given the ability of both the Eurozone economy and the Central bank to disappoint, traders will most likely wait to hear what she has to say next week before jumping into speculative mode.

The Head of the Banque de France commented at the weekend that adaptations to the bond purchase facility can take place at any time, and there are still four meetings to go until the end of the year.

The euro remains fairly unmoved by Lagarde’s comments.

It rallied to a high of 1.1880 but fell back a little to close at 1.1836. It will need to break and hold above 1.1920 if another assault on the 1.20 level is to happen this side of the summer lull.

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.”