MPC must tread carefully
15th March: Highlights
- Bank of England on a tightrope
- Unwind of support to begin this week
- ECB planning to be more flexible
Excessive rate hikes could destabilize the economy
Tenreyro believes that the Central Bank was already facing some tough decisions even before Russian troops crossed the border into Ukraine.
With the economy yet to completely recover from the Coronavirus Pandemic, there is a real chance inflation is set to rise further. The Bank, already having hiked interest rates at its two most recent meetings, is now expected to hike again this week as the MPC reacts to the balance of risks.
Andrew Bailey, the Bank’s Governor, spoke last year of his desire as the economy emerged from the pandemic that the MPC would be able to keep control and not be driven by events. It was on track to achieve that goal with consecutive hikes. However, the conflict has blown that desire off course.
Inflation is still well above target and is expected to rise further, the economy is slowing, and the population faces further pressure on household budgets driven by two major negative factors due to take effect next month.
Market expectations that the Bank will choose inflation over growth as its target is growing, with another twenty-five-basis point hike now looking certain.
Data for employment in February will be released this morning and since the numbers refer to the period immediately prior to the conflict, they are expected to continue the recent improvement.
The pound remained under pressure yesterday, it fell to a low of 1.3001, closing at that level. It is expected to find a degree of support around the 1.30 level, but sentiment remains negative as the dollar continues to rally.
Twenty-five Basis Point hike now baked in.
It is now common knowledge that the Central bank has been late to the party, despite being only the second arrival at this point.
Through the final quarter of 2021, it had been expected that the Fed would be the first to hike but was overtaken by a couple of months by the Bank of England.
A rise in interest rates would generally signal strength for the currency, but this week’s hike was so well telegraphed that if anything the dollar may face renewed downwards pressure this week.
While Jerome Powell has expressed desire for a twenty-five-basis point hike, there are still a minority of Regional Federal Reserve Presidents who make up the FOMC, who favour a front loading of the hike, believing that a fifty-basis point hike would send a strong message of the Fed’s intentions to the market.
Powell will also deliver the Fed’s outlook for interest rates, GDP, inflation and employment.
The data for non-farm payrolls so far this year has been encouraging, but the total remains below pre-covid levels and vacancies remain above 11 million.
Wages are beginning to show signs of increasing as the level of vacancies remains constant, and the Central Bank will be aware of the inflationary consequences of significant increases despite real wage increases remaining in negative territory.
As well as the conclusion of the Fed meeting tomorrow, data for retail sales is due for release.
Despite the reopening of the economy, sales are expected to have fallen following a significant increase in January. It is predicted that there will be an increase of 0.5% following January’s rise of 3.8%.
The dollar continues to garner support on safe haven plays. The index rose to a high of 99.29 yesterday, closing at 99.12
Current policy is far from set in stone.
It finally bowed to the pressure being exerted by rising inflation and decided that extraordinary support that has been in place since the start of the Pandemic would begin to be tapered and end before year-end.
Christine Lagarde was, however, certain in her desire that rates won’t rise this year, even if the market took her words with a pinch of salt.
Lagarde tried to be as vague as she was about the timing of any hike in rates, although given the disunity of the Governing Council, it may be that she has no firm idea when that will happen.
Lagarde is still dovish in her outlook for the economy and would press for a slowing of the taper, were inflation to begin to fall naturally.
In truth, that is unlikely to happen given the coast of energy that is badly hurting the more industrialized nations of the Eurozone.
The European Union in general and Germany in particular, have fostered close ties with Russia over several years and while there is a significant level of abhorrence at Vladimir Putin’s actions, there remains a desire to work with Russia should sanctions be reversed and the import of Russian energy return.
This possibility is clearly some way down the road, but it could be the only path to the Eurozone avoiding a recession and possibly reversing a fall into stagflation.
The euro has been the most affected currency following the Russian invasion of Ukraine, although it has now been closely followed by Sterling. It therefore follows that any positive news will see the euro recover. It has managed to regain close to the 1.10 level versus the dollar as talks between the two nations show small signs of positivity.
There is clearly a long way to go, and Ukraine simply will not consider Russian demands, but hope springs eternal.
The single currency rose to a high of 1.0994 but fell back as there was no follow through and closed at 1.0940.
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.”