15 July 2022: At last, a bold plan!

At last, a bold plan!

15th July: Highlights

  • Sunak remains favourite, Truss and Morduant fight for second place
  • Wholesale inflation surges, Biden sees approval rating collapse
  • EU cuts growth expectations as expected

GBP – Truss sees a bright future following a few bumps

It now seems likely that the prediction of Rishi Sunak plus one other contesting the final ballot to be Conservative Party Leader will come to fruition next week.

A third ballot will take place on Monday and it is probable that the second candidate will be between Foreign Secretary Liz Truss and the Minister of Trade, Penny Morduant.

The level of backbiting and innuendo between candidates has, so far, been fairly low, but as the prize comes closer, so the fierceness of the competition will rise.

Truss spoke yesterday of her determination to ensure that the economy is back on track, by the time of the next election.

She injected a degree of realism by accepting that things will get worse before they get better with this winter expected to be especially tough as the cap on fuel prices will be adjusted upwards again in the Autumn, bringing the average family’s energy bill close to £3,500 per annum.

Sunak when asked about the other contenders plans for tax cuts which he has eschewed so far said that bringing inflation down is the most important criteria for the Government now, while any cut in taxes can wait until the economy is on a surer footing.

The Bank of England’s Monetary Policy Committee doesn’t meet until the first week of August, so its members have an opportunity to study the continued rise of inflation. The fact that the economy managed to grow in May according to the latest figures may encourage them to become emboldened and raise the rate by fifty basis points.

So far, the drip feed of interest rates increases has had little discernible effect on inflation even though demand has fallen.

The more dovish members of the MPC will point to the fact that the increase in rates by one per cent since last December has had little apparent effect other than to contribute to the current slowdown.

They will say that should the economy slip into recession, that rate increases will need to be reversed in order to provide stimulation. They will also argue that since inflation is prevalent primarily in the supply side of the economy, which rate hikes do not address, that a pause would be less damaging than a fifty or even seventy-five basis point increase.

The pound has been under pressure all week versus the dollar. Yesterday, it fell to a low of 1.1760, the lowest point it has seen since the beginning of Covid-19 restrictions, and closed at 1.1822.

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USD – Biden carrying the can for outside influences

The first half of Joe Biden’s Presidency has been little more than firefighting as the fallout from the Capitol Hill riots following his election continues.

Other than to bring into stark review the difference in political attitude between Republicans and Democrats, Biden has very little practical to show for his first two years in office.

He is accused of allowing Russia to gain the upper hand in global influence by being able to invade Ukraine virtually unopposed, despite not showing its military might in any way other than the number of troops it has at its disposal.

The price of energy has soared, with a gallon of petrol exceeding five dollars for the first time.

Although soaring inflation is a global issue, Biden has been accused of stoking the fire by being too generous with his support payments during the Pandemic. The feeling is that Biden is still considered new to the job, despite actually being halfway through his first and if his plummeting approval rating is anything to go by, only term.

The fight against inflation continues, with the FOMC determined to bring it under control, in spite of the fact it appears to have one hand tied behind its back. Lowering demand has so far failed to bring inflation down, as this week’s release of data for June has shown.

While the headline continues to rise driven by the food and energy sectors, core inflation is beginning to slow and even turn lower, albeit virtually unnoticed.

The question of a recession remains. Banks have been releasing H1 earnings figures, with J.P. Morgan and Bank of America the first cabs off the rank yesterday. Their numbers were gloomy at best, drawing more concerns about a possible recession.

It may be sacrilegious to question expansion or contraction in the economy, but with quarterly growth running at or around zero, is the fear of a recession worse than the actual event?

It may very well be that the series of hikes have slowed the economy to a crawl and may even contribute to what everyone agrees would be a mild recession but at 0.5 percent or minus 0.5% what is the actual rather than manufactured effect?

There is very little at that level to point to. Factories aren’t closing, there is no change in the strength of the labour market, yet the fears of recession are becoming tangible.

One contributor to the fight against inflation is the strength of the currency. So far this week, the dollar index has continued to make fresh highs. Yesterday it reached 109.28 but fell back to close at 108.65, its highest close since the index was created.

EUR – Italy in turmoil as the coalition collapses

As expected, the EU Commission yesterday lowered its expectations for growth in 2022 and 2023 for the entire Eurozone and raised its expectation for inflation.

The predictions appear to be a little on the generous side, drawing comments that they will need to be lowered again, when the next forecasts are released in three months’ time.

There is very little, if anything, to commend investment in the region currently, with a war raging on its doorstep and indecision about monetary policy and political turmoil returning.

In Italy, one of the larger parties, withdrew from the ruling coalition, The Five-Star Movement refused to take part in a no-confidence motion raising fears about a snap election.

Until very recently, Marion Draghi had been considered to be the only man to save the Italian economy, but last night he was forced to meet with the country’s president to offer his resignation.

This was not accepted by Sergio Mattarella. Draghi’s coalition is now in a minority and despite the former President of the ECB enjoying almost total support, it is likely that it will fall.

Given the current economic situation in Italy, an election now would be the worst of all outcomes and Draghi is expected to try to engage Five-Star in dialogue to try to get them back onside, for the sake of national Unity.

In any vote, it is expected that Draghi would remain as Prime Minister since he would be the choice of a fractured Parliament, but he may consider trying to manage the country while shackled to a populist, anti-establishment partner.

In the wider eurozone, the talk remains of the size of the hike in interest rates that will be agreed at next week’s ECB meeting.

Currently, it is a fact that inflation is out of control, which a contraction of the economy while likely to become a reality is an issue for the future despite the fact that that future is now well above the horizon.

A twenty-five-basis point hike could be the catalyst for a far more serious political situation than is happening in Italy, since it may bring into question the traditional influence that Germany has had over financial matters in the region.

The euro took a look at the scenery below parity yesterday and didn’t like what it saw and quickly retreated back. It reached a low of 0.9952, but closed at 1.0001.

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.”