15 March 2021: Economy to contract in Q1?

Economy to contract in Q1?

15th March: Highlights

  • Brexit brings slump in exports to Europe
  • Covid recession now well into the rear-view mirror
  • Eurogroup to continue measures for as long as it takes

Support not stimulus remains vital

The UK economy shrank in January.

The barely surprising statistic that the economy contracted by 2.9% in January and the fact that it was appreciably better than predicted barely registered.

The lifting of lockdown measures, the barely credible success of the vaccination programme and the forward-looking measures announced by Rishi Sunak in the Budget have given the country a shot in the arm that was becoming desperately needed.

The debt of gratitude the nation owes to both the NHS and the scientists who discovered the vaccine is immeasurable and may in time be compared to the breaking of the enigma code in World War Two.

The world’s economy has been subject to globalization as just about every form of communication has been sped up and forever changed by the digital age and the invention of the world wide web and internet.

The Pandemic has spawned a new term to counter Globalization. Perverse nationalism has broken out.

Brussels has accused the UK of it over trade passing through Northern Ireland while Italy has been accused of holding back vaccine doses for its own use.

The better-than-expected contraction in the economy in January is in itself perverse since it is based upon the fact that UK business, hammered in the extreme by lockdown measures has adapted better than could have been expected.

While it is clear that Q2 will be significant, as mentioned last week, the jury is still out on the longevity and robustness of the overall recovery.

The other side of the coin from the adaptability of manufacturing and industry even though it is a little more than 20% of overall productivity is that output fell by appreciably more in January than analysts had expected.

The pound was entirely driven by the machinations of the dollar last week. The birth of Bidens stimulus package saw the pound fall to a low of 1.3800 before recovering to end the week higher overall at 1.3929. This was almost a mirror image of the range from the previous week.

In the short term, provided the dollar reacts a little more predictably to economic events, then the pound should, in the short term continue to be viewed positively.

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Questions continue to be asked

Inflation, or at least worrying about it, used to be the sole province of the Bundesbank but another consequence of globalization has been the joining up of monetary policy actions amongst the G7, which then spread throughout the developed world.

One easy to spot inflationary aspect of the global recovery from the Pandemic, even though it will be delivered at several different paces, will be the increase in fuel prices.

If we take that back a stage further as restrictions are lifted in the U.S. consumption is going to skyrocket and the blue touchpaper has now been lit.

President Biden signed his $1.9 trillion stimulus package into law last week and some households will have already received their $1.4k benefit cheques in the post.

It may very well turn out that you can lead a horse to water, but you can’t make him drink, but it is far more likely that the entire air of optimism coursing through the economy will see far higher retail sales this weekend than have been seen in any non-holiday setting for some years.

Of course, in most States those sales will have been online, but the loosening of the valve on pent-up demand has begun.

The FOMC meets this week and Jerome Powell’s news conference is likely to be a significant driver for the currency. The only issue is that the direction is unknown.

Most spectators expect Powell to remain dovish for two reasons. First, he is not prone to knee-jerk reactions and likes to see his policies given time to mature.

Second, he is prepared to be reactive to any increase in inflation. That means that he can simply watch the entire scenario develop.

He will provide advance guidance to the markets but will also allow them to make their own minds up.

There will be no change in interest rates at this meeting while the purchases of $80 billion of Treasuries in $40 billion in mortgage-backed securities will also be unchanged. However, it is almost certain that the level of purchases is now at its highest point.

The dollar index is giving off signals that it is only a matter of time before there is a matrix of currencies that are all traded against baskets. In the meantime, it was especially volatile last week. It traded between 92.50 and 91.36.

It is unclear whether Eurogroup will cap facilities

The cost of the Pandemic to the Eurozone is not yet known but it is doubtful that the support from the Recovery and Resilience Fund (why do they name everything in English) is going to be sufficient.

The Eurogroup will meet later today, and they are likely to approve an increase in the fund to Eur 672.5 billion.

The fact that Italy, that is scheduled to account for Eur 200 Billion of that has, had to reintroduce restrictions at the weekend to stave off a third wave, does not bode well.

Last week’s ECB meeting did nothing to bolster confidence amongst those nations that are struggling.

The rollout of the vaccination programme is still suffering, and questions remain concerning the veracity of claims about when it will be complete.

With the Union certain to be in recession until at least the beginning of Q3, the boost delivered by a lifting of lockdown restrictions is becoming vital.

The new Italian lockdown is a significant concern, since evidence shows that the origin of the Pandemic in Europe emanated from Italy and as such it is likely that the spread could begin again even though Brussels is now far better informed.

One of the more obvious statements made during the entire Pandemic was made by the President of the Banque de France last week when he announced that there is no danger of the economy overheating.

Even a glimpse of inflation would be welcome right now, but the spectre of a rarely, perhaps never, seen beast, stagflation, is a real possibility.

If activity remains as low as is likely for the rest of 2021 and, for instance, the oil price rallies towards $100, the effect on the Eurozone could be devastating.

The Eurozone faces attacks on several fronts before it is able to emerge from the Pandemic and even then, no one has any idea what state it will be in, but the most burning question is; does it have a Central Bank that is able to drive the economy forward.

The euro was by no means immune to last week’s volatility. It traded between 1.1990 and 1.1835, closing at 1.1960.

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.”