13 October 2023: Pill sees economic risks as delicately balanced

Huw Pill, the Bank of England’s Chief Economist believes that the risks to the economy are currently delicately balanced between fighting inflation and promoting growth.

That means the decision of the MPC about whether to return to the cycle of interest rate hikes that was paused in September is likely to be driven by the members’ interpretation of the situation rather than data which still is mixed and doesn’t supply a hard and fast conclusion.

Last month there was the first sign of the departure from “groupthink” in which the permanent members of the Committee vote as a block as the Bank’s Deputy Governor for Financial Stability, Jon Cunliffe “broke ranks” and voted for a hike which most members of the Committee disagreed with.

The next meeting may show the benefit of having independent members who are drawn from both academia and the financial markets.

Catherine Mann has remained hawkish about the need to not only fight inflation but be prepared to “overshoot” by raising rates to such an extent that inflation is driving lower even than the 2% target.

Swati Dhingra, meanwhile, takes the opposite view and ever since her introduction as a member of the MPC in September of last year has voted to leave rates unchanged. She believes that there needs to be a pause between rate increases to allow the economy to “catch up”.

So far it seems that the more hawkish ideas of Mann appear closer to reality as inflation has proved stubborn and the need for interest rates to reach a level when they are restricting demand sooner rather than later will provide the stability that the economy needs.

It is hard to pinpoint the exact points where rates turn from accommodative to neutral and then restrictive since different sectors of the economy react in diverse ways.

Private consumption is affected by rate increases more rapidly than both industry and services which are both more able to make provision than households that see increases in mortgage rates and the cost of living damaging their disposable income.

There is little doubt that the economy is going through a paradigm shift which was precipitated by the Pandemic and the end of the era of low interest rates.

Next week will provide a clearer picture of what to expect from the MPC as both employment and inflation data for September is published.

Headline inflation is expected to remain above 6.5%, while the core with volatile items like energy and food stripped away will be closer to 6%.

Average earnings are expected to remain above the rate of inflation which promotes the idea of a wage/price spiral which will concern the Bank of England, while the claimant count is expected to remain around 4%.

Yesterday the pound “handed back” most of the gains it has made this week as the dollar reasserted itself. The IMF which is holding its annual meetings in Marrakech this week spoke of its concern about the conflict in Israel and Gaza having a profound effect on the global economy, which saw the dollar gain as risk aversion took hold.

The pound sank to a low of 1.2171 and closed at 1.2176.

The opinions of the team of economists that work behind the scenes at the Federal Reserve have appeared to be a little “behind the curve” for most of this year as they have constantly had to deal with the effects of monetary policy changes that have led from being accommodative to briefly neutral and now restrictive upon demand.

Considering the two pauses that have taken place in the past three months and the employment data that shows the economy still creating jobs at a rate that defies tighter monetary policy, their overall conclusion is that the economy is headed for a soft landing.

In reality, that means that the increase in new jobs created will stabilise and fall to a level that remains positive while inflation will continue to get closer to the Fed’s target of 2%.

Timing of the soft landing is far from an exact science since there are a considerable number of “moving parts” to the economy which are affected by an even more considerable number of drivers.

Changes in monetary policy are a “broad brush” approach and as such Jerome Powell’s assertion that the fall in inflation will not be linear is being proved correct.

The latest inflation data that was released yesterday showed that headline inflation was unchanged in September while the core continued to fall. It is now considered unlikely that the FOMC will continue its pause when it meets again at the end of the month.

The surprising number of new jobs that were created in September when coupled with the failure of headline inflation to continue its downwards path makes a further hike reasonably certain.

The constant changes in the global economy make the delivery of monetary policy difficult and with the turmoil that is being created in the Middle East currently that task is made even more difficult.

It was only a matter of time before the dollar reacted to global uncertainty and the comments from the head of the IMF yesterday proved to be the catalyst to end the Greenback’s recent lethargy.

It rose back above its short-term level of support that it had threatened and reached a high of 106.60 and closed at 106.58. The market will be closely watching developments today and over the weekend which may lead to further volatility in the early part of next week.

In a major speech that marked his return from a self-inflicted period in the shadows, former ECB President Mario Draghi, a man whose words hold a significant degree of weight both in Italy and the wider Eurozone spoke of the need for the European Union to create a unified fiscal policy that will support monetary union.

As the Eurozone has matured it has been hampered by the fact that individual nations are able to “adjust” the impact of tightening monetary policy using fiscal policy, which entails adjustments to rates of taxation and social benefits.

There is the added issue of the political picture across Europe which endures at a national level and detracts from the effectiveness of the European Parliament.

Whereas in the UK, local council elections are often considered a “protest vote” and deal mainly with local issues such as council tax, refuse collection and street lighting, the opposite is true in the Eurozone.

National Elections signal any change in the political “mood” of individual nations, while the European Parliament is considered more of a “talking shop”. Which runs on a more hypothetical level.

For the Eurozone to become more globally recognized, it needs to create a more “Federal” persona whether the highest level of bureaucracy is replaced with an authority that has “teeth” and can create policy for the entire region.

A unified defence budget and armed services under the command of a single entity would make reaction to the Russian invasion of Ukraine more strategic and not allow Vladimir Putin to target individual nations as he has with Germany over energy supply, which has weakened the response of the entire region.

Until fiscal and monetary are created in union, the European Union will be little more than a group of individual nations with a single currency and a whole load of loose affiliations.

The Euro suffered from the renewed strength of the dollar yesterday as the market reacted a little belatedly to the threat posed by the turmoil in the Middle East.

The single currency fell to a low of 1.0525 and closed at 1.0528.

Next week harmonised inflation data will be published which will determine the likely continuation of the ECB’s policy of higher interest rates, but it will be events in Israel and Gaza that overshadow the common currency.

Have a great day!