- Economy was flat in February
- Fed analysts expect the banking crisis to drive the economy into a recession
- Governing Council in turmoil about the size of the next hike
Hunt draws criticism over lack of realism
The latest strike by junior doctors which has seen a four-day walkout this week looks to be the most contentious. Nurses and train drivers have accepted offers recently.
After monthly growth of 0.4% in January, the economy had been expected to post further growth and the zero number disappointed the markets.
Chancellor of the Exchequer, Jeremy Hunt has been accused of painting an overly optimistic view of the economy recently. He commented recently that the economy is faring better than expected, continuing weak data.
Andrew Bailey, the Governor of the Bank of England, speaking at the meeting of the IMF in Washington, asserted that the UK financial system is robust, and he is not expecting any further contagion from the recent turmoil.
He did, however, hint that the Bank is looking into increased deposit protection for savers, something that was recently studied and rejected in the U.S. by Treasury Secretary, Janet Yellen.
While Government sources are quick to reject Brexit as a reason for the stagnation of the economy, it is fairly clear that there has been a downturn in activity since 2016 which has become more obvious since 2020, even taking into account the Pandemic.
There will be concern at the Central bank which may already be considering a pause in its series of rate hikes that stretched back to December 2021.
The pound is showing resilience against the dollar, although a fairer reflection of its relative performance can be seen by comparing how it is faring against the Euro and Yen.
Versus the single currency it has begun a downturn yesterday reaching a low of 1.1313 and closing at 1.1337. Against the Japanese currency, it broke a series of higher closes by falling to 165.41 and closing at 166.01.
A weaker dollar saw Sterling rise to a high of 1.2537 and close at 1.2522.
Next week will see the publication of the March employment report as well and the latest data for inflation.
Price increases are expected to have slowed with the headline falling to 9.9% and the core reaching 5.9% after a rise of 6.2% in February. Food price inflation will remain high reflecting continuing shortages due to bad weather and supply chain issues.
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Fed insists on vigilance on credit
This is particularly relevant now as the market takes note of an internal report prepared for the FOMC in which in-house analysts predicted that the turmoil in the financial markets would lead to a shallow recession later this year.
That view has been rendered inaccurate over the ensuing period since the banking sector has shown its resilience and the Treasury has acted promptly to ensure that there is no lack of liquidity, while banks themselves have shown an unusual degree of confidence in each other by retaining lines of credit and not driving a serious situation into a crisis.
A further takeaway from the minutes was the change to a less hawkish attitude to inflation. This will have been strengthened by the subsequent release of the March inflation report which showed that although the more volatile headline ticked up slightly last month, there was a solid fall of 1% in the core from 6% to 5%.
While stressing the importance of vigilance over markets, FOMC members are most likely fairly satisfied with how the collapse of two regional banks has been absorbed by the markets.
It is felt by the markets that the recent fall in inflation may drive the dovish attitude of the FOMC even further and lead to a pause in the recent run of interest rate hikes.
In a note to investors yesterday, J.P. Morgan noted that Jerome Powell appears to have little faith in forecasts, and this will lead to the Central bank being even more reliant on data to show how the economy is slowing. If that is true, then traders can expect a rate pause as inflation continues to fall.
The dollar has suffered this week as the market considered the likely ramifications of the March inflation report. The conclusion is that if the FED increases rates at its May meeting, it will almost certainly be the last in a long line of hikes.
The dollar index fell to a low of 101.45 yesterday and closed at 101.53. Unless there is a sudden turnaround in market sentiment a test of the 100 level now looks likely.
Rumours of convergence wide of the mark
It seems that this is little more than wishful thinking on their part, given that one of the most listened to Council Members, Austrian Central Bank Governor, Robert Holzman commented a day earlier that a combination of recent data and the Central Bank’s own internal forecasts point to an increase of fifty basis points.
Holzman’s views were backed by Spanish Central Bank Head, Pablo Hernandez de Cos who agreed that rates will need to be raised for a longer period since inflation is still a significant issue.
Six successive fifty point hikes have only had a moderate effect on rising prices and there are questions being asked by economists whether the return of inflation, which hasn’t been an issue for a significant time, may be systemic rather than part of the normal economic cycle.
The lack of a coherent fiscal policy covering the entire European Union is also being cited as a reason why the ECB cannot seem to get a handle on price rises.
There have been some quotations asked, by Italian economists in particular, about whether a period of gradualism may serve the entire region better, especially as it is now generally felt that short term interest rates are now at, or very close to, restricting economic growth.
There is some debate about the ECB’s quarterly lending survey which will be published just a few days before the next ECB meeting which is likely to show a fall in activity. The April inflation report will also be available to Governing council members ahead of its next vote on interest rates.
The euro has now breached the 1.10 level versus the dollar and made a new high for the year yesterday. It reached a high of 1.1067 and closed at 1.1046.
It remains to be seen how resilient the single currency is in its own right, since its current strength is due to a perception of a widening of the interest rate differential between it and the dollar.
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13 Apr - 14 Apr 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.