14 November 2023: Climate change may bring more persistent inflation

Bank of England Monetary Policy Committee member, Catherine Mann outlined her opinion that inflation is set to remain an issue for G7 economies due to a variety of reasons including climate change.

The structure of the global economy is constantly evolving and the low inflation/low interest rates era that began as a reaction to the downturn created by the 2008 financial crisis was ended in spectacular fashion by nations’ need to pour support into their economies following the Pandemic.

Mann believes that climate change policies that in the past have been considered an issue for insurers and banks will become an issue for the wider economy. She believes that carbon taxes and emission trading could potentially have a similar effect to oil price shocks in the future.

Although this is a long-term issue it is becoming an issue in the two to three year “window” that the Bank of England concentrates on.

To some this will seem to be little more than a continuation of Mann’s apparent infatuation with inflation which has seen her become far and away the most hawkish member of the MPC.

There is a continuing and expanding difference of opinion between the permanent members of the committee and its independent members, who appear to be more hawkish. Apart from Mann, Megan Greene who joined three meetings as a replacement for Silvana Tenreyro has brought another hawkish element to the discussion.

Where Tenreyro had an extremely dovish attitude to inflation, warning at the time of her departure that the Bank risked pushing inflation below the 2% target by continuing its cycle of rate hikes, Greene has voted for a hike at each of her three meetings so far.

Today’s publication of the October inflation report will likely be overshadowed by the continued fallout from yesterday’s Cabinet reshuffle which saw the Home Secretary Suella Braverman unceremoniously sacked and replaced by former Foreign Secretary James Cleverly.

However, Rishi Sunak surprised every political commentator by appointing former Prime Minister David Cameron., as Cleverly’s replacement at the Foreign Office

While he may very well be the “best man for the job” in the current environment, Cameron’s appointment is unlikely to do much for Party unity given his “remain” credentials.

Unemployment is expected to rise as the effect of the rate hikes that have taken place continues to affect demand, while average earnings are likely to continue to moderate.

The pound rallied to a high of 1.2280 yesterday and closed at 1.2276 as the dollar’s recent rally took a breather.

Traders and investors in the U.S. are not showing any patience with the Fed over monetary policy. No sooner has the Central Bank probably brought to an end its cycle of interest rates hikes, then the market is almost clamouring for information about when rates will begin to be cut.

The Fed is the one G7 Central Bank which hasn’t commented about how long rates are expected to be at an elevated level as has been seen from the ECB and the Bank of England and this is seen as a “chink of light” by commentators who feel that the FOMC will be pressured by a rise in unemployment to cut rates “sooner rather than later”.

The fact that Fed Chairman Jerome Powell and some of his colleagues on the FOMC are still of the opinion that possibly not enough has been done yet to ensure that inflation falls to its 2% target in the medium term appears to be of little consequence.

It is a novel approach to look at the employment numbers as a source of inspiration for rate cuts given that even as the economy apparently begins to slow, it managed to create 150k new jobs in October and close to 300k in September.

It will take until at least the end of the year for the rate hikes that have taken place so far to work their way through into the wider economy and the Fed has time as mentioned by acting St Louis Fed President Kathleen O’Neill Paese, recently to evaluate fully its next move given the resilience of the economy.

The October inflation report is due to be published later today and is expected to see a moderate fall in both the headline rate, while the core remains unchanged.

Headline inflation is likely to have fallen to 3.3% from 3.7% in September, while the core with volatile items like food and energy stripped out will remain at 4.1%.

The next meeting of the FOMC is not until the 13th of December, so there is still time for an evaluation of the economy to take place, but unless today’s data is way out of line the Fed’s activity for the year is already at an end despite Powell’s moderately hawkish recent comments.

The dollar index remains in a range bordered by the correction it made in the wake of the October employment report on November 3rd. There is selling interest around 106.25 but good support at 105.00.

Yesterday, the index fell moderately to a low of 105.58 and closed at 105.66.

The ECB often appears to be like a supertanker in the way it takes an age to either slow to a stop or perform a manoeuvre.

Having taken what history may prove to have been far too long to end its cycle of interest rate hikes it is now placing itself in shackles by informing the market that there will be no cut in interest rates in the first half of 2024 and that it doesn’t expect inflation to reach its target level of 2% until some time in 2025.

It may be a factor of there bing “too many cooks” that members of the Governing Council feel that they have to comment on monetary policy in order to feel important.

The ECB’s Vice President, Luis de Guindos reminded the market yesterday that inflation may rebound marginally in the coming months before resuming its downward path.

Any rise in inflation is likely to “inflame” the hawks on the Governing Council, especially Austrian Central Bank Governor Robert Holzmann, who commented recently that the cycle of rate hikes may not be over.

The Head of the Banque do France and the Dutch Central Bank Governor have assumed a more conciliatory role recently.

Both agreed that the pause in rate hikes was agreed in a timely fashion given the views of the entire Council and while they both feel that rates should remain elevated for some time, neither is prepared to put a time limit on when cuts will take place.

Christine Lagarde is repeating the error that she made earlier in the year by giving definitive advance guidance to the market. Earlier, she often promised a further hike in her press conference following the end of an ECB meeting and now, she is confirming that it will be two quarters before any rate cuts can be considered.

A degree of nimbleness is necessary to deal with any change in the outlook for both inflation and growth since there are several “moving parts” that need to be managed.

The euro remains in a fairly narrow range which at least suits the ECB. Yesterday it saw some modest buying interest and climbed to a high of 1.0706 and closed at 1.0699. It is unlikely to find the impetus to break above 1.0730 unless there is a surprise from today’s U.S. inflation data.

Have a great day!