Higher inflation creates dilemma for BoE
August 15th: Highlights
- Higher inflation, lower growth to vex MPC
- German economy contracts as recession beckons
- Dollar rallies despite recession signal
Brexit the centre of all UK’s issues
However pressing Brexit is, the economy is starting to slow considerably and give cause for concern. Last week’s contraction in the second quarter means that the Bank of England may be looking at keeping interest rates on hold a little longer. However, a stronger than expected employment report for July which, while not as significant as in the U.S., showed that it is not the entire economy that is suffering.
Yesterday’s inflation report created a rather more serious dilemma for the Central Bank. The precipitous fall in the value of the currency since Johnson became Prime Minister has started to push inflation higher. Year on year, prices grew by 2.1% in July, up from 2% in June and well above the market’s consensus view of a 1.9% increase.
Central Banks across the entire G7 are struggling with various scenarios, all different, yet all causing concern. The Bank of England has been sidelined so far this year as it has left Brexit negotiations to the Government while waiting to be able to model the effect of the several scenarios on offer.
With no deal becoming more likely by the day and the economy starting to weaken, Governor Carney will be starting to feel it is time to act. The only question is “by doing what?” Lower growth and higher inflation is the Central Bankers “nightmare scenario”. Do we cut rates to add stimulus or raise them to stave off higher inflation? It is unlikely going forward that the currency will help inflation since given the probable outcome of Brexit, it is likely to remain weak.
Yesterday, the pound traded in a narrow range versus the dollar between 1.2101 and 1.2044. It closed at 1.2060 just a single pip higher than from Its opening level.
Germany failing to provide guidance to the Eurozone
GDP data for the second quarter was released by the EU’s powerhouse economy yesterday and it made for a very depressing reading. The German economy contracted by 0.1% in Q2 as was expected by the market. Despite this being expected it is no less a surprise that German dependence on global trade has made it so reliant on other nations performance.
While global trade has undoubtedly been skewed by China’s growing influence, it is in areas where Germany has traditionally been strong such as innovation in the vehicle industry and heavy machinery that it is suffering most.
The EU is suffering mostly from its inability to act and having one foot in the past while it acknowledges its original “raison d’etre’, it has been unable to move with the times. It has been weighed down by the increasing bureaucracy which Brussels deems necessary to provide the population with a generally level playing field.
The larger EU economies such as France, Spain, Italy and Belgium/Holland had all expected to be pulled along by German manufacturing and industrial excellence. Instead, some of those economies and several of the former Soviet states have proven to be a millstone which Germany has been forced to drag along.
It seems that with the ECB unable to provide any stimulus and the ploy of simply “waiting out” the period of zero growth not working, the Eurozone will be in for a tough winter.
Yesterday, the single currency traded down to a low of 1.1130 versus the dollar, closing at 1.1138.
Is the U.S. really on course for a recession?
The last time this happened was in 2007 and we all know the devastating financial crisis that occurred within a year.
Weak economic data released by Germany (see above) and China, as well as pessimism over the progress being made by Washington and China in trade negotiations, cast a pall of gloom over the markets. There is a growing sense that the U.S. economy was defying the lack of growth globally and it could only buck the trend for so long.
If there was ever a case of someone being right for all the wrong reasons, it could be President Trump. He called for a more concerted round of interest rate cuts simply to push the equity markets higher. It may be that rates have to be cut in order to save the same stocks from going out of business.
The U.S. economy will be the major focus as Q3 ends with data being far more closely scrutinized. A slowdown doesn’t necessarily mean the dollar will collapse as it retains its safe-haven status.
Yesterday, the index rose to a high of 98.05, closing at 97.99.
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.”