16 August 2022: Growing calls for halt to energy cap

Growing calls for halt to energy cap

16th August: Highlights

  • Deep recession fears grow
  • Housing index falls to major low
  • Stagflation to test EU resolve

GBP – Labour promoting vote-winning idea

The opposition Labour Party has stolen a march on the Government by announcing that were it to be in power, it would freeze the energy cap for six months.

While the two candidates to replace Boris Johnson as Prime Minister have spoken in very general terms about plans to help consumers as the cost-of-living crisis escalates, this is the first solid and practical solution that has been suggested.

The opposition leader, Sir Keir Starmer, has suggested that the freezing of the cap could be funded by a windfall tax on energy firms who have made record profits as prices have risen.

Now, whoever wins the Conservative Party leadership election is facing a dilemma, since if they adopt such a scheme, they will face accusations of not having sufficient imagination to produce such a proposal.

This week will see both employment data and the inflation report for July published.

It is expected that the claimant count will continue to fall. In June, 20k less people claimed unemployment benefit, while in July it is expected that that number will be closer to 30k. There remains a shortage of workers in several sectors of the economy, this is primarily due to the continued effect of EU workers having departed following Brexit.

The continued fall in unemployment, with the headline rate expected to remain below 4% is a significant contributor to core inflation. With the price of petrol having fallen with supermarkets having entered something of a price war recently, headline inflation is expected to have peaked, although that may change if the increase in the energy cap due to take place in October remains.

Headline inflation is expected to have fallen to 9.2%, although there are still fears that the continued rise in the cost of foodstuffs may negate the fall in petrol prices.

The Bank of England will be keen observers of this week’s data releases, as the MPC will meet on September 15th. With inflation still almost five times the Government target, it is likely that a further fifty basis points will be added to official interest rates.

The pound continues to drift versus the dollar as a lack of new divers continues. Yesterday, it fell to a low of 1.2050 as the dollar saw some renewed buying interest, it closed at 1.2054.

It could threaten support at 1.2020 should the data due for release over the next 36 hours increase the possibility that the Bank of England could halt or at least reduce its recent more hawkish stance.

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USD – Powell willing to risk deeper recession to meet goals

Despite the most recent meeting of the FOMC producing a slightly less hawkish outlook for monetary policy. Its chairman, Jerome Powell still sees bringing inflation back to the administration’s target of 2%.

G7 Central Banks, except for Japan where there remain exceptional circumstances, all believe that the key to achieving their dual goals of promoting employment and consistent economic growth hinge on bringing price rises under control.

The Federal Reserve was prepared to allow inflation to rise last Autumn since it accepted that strains on supply chains would see demand outstrip supply, but as this did not correct itself naturally, it has been forced to act.

Dampening demand by ending an era of historically low interest rates has not had the effect that was expected, and this has been mostly due to low and falling unemployment. The Fed has brought interest rates back to what many consider to be a neutral point where monetary policy is neither expansive nor restrictive.

Any further rise will be seen as actively risking growth and pushing the economy deeper into a recession, which, technically, it is already in.

Powell has constantly agreed with commentators who say that the FOMC is playing with fire. Although he understands that driving the economy into a recession is a risk, he believes that it is one worth taking.

The biggest fear is that once in recession, output may be affected to such an effect, that it will drive a significant correction in equity markets that could be almost impossible to stop.

So far, stock markets have continued to show confidence in Powell and his colleagues, especially since he is a Republican, and his party is traditionally a friend of Wall Street.

Data for housing starts and building permits are due for release today. They will follow yesterday’s report on the overall condition of the housing market, which showed a significant fall.

Today’s data is often seen as an early warning about the long-term health of the economy. If they predict a high degree of probability that the current recession will deepen, the dollar may reverse the gains it made yesterday.

The index rose to a high of 106.55 and ended the day close to that level.

EUR – Lagarde unable to find true support no matter what

The European Central Bank, having raised interest rates at its last meeting, a move that its President justified by saying that it had been part of an extensive strategy review which took place last year, is going to face significant opposition if it wished to repeat this at its next meeting.

While Germany is committed to fight inflation, a position that is scored into its national psyche, its government is aware of the concerns that will arrive with the first cold spell of winter.

While Europe has basked in heatwave conditions which bring their own concerns, the inability of the country to replenish stocks of gas before winter sets in have been severely diminished by the reduction in the flow of gas coming from Russia.

It is hard to imagine the repairs to the facilities that Russia asserts are causing the issue will be completed before next Spring. By then, the damage to the German economy as well as to the wider Eurozone will have been done.

There is a real possibility that Germany will have to go back on the most significant pre-election policy promised by Chancellor Olaf Scholz.

He promised that all coal-fired power stations would be decommissioned in short order and that use of nuclear energy would be scaled back significantly.

It is well known that gas is a more efficient, cleaner, and safer method of producing electricity, but as one commentator noted recently, Germans may have to go back to burning wood if the situation worsens significantly.

Stagflation remains a major concern for the Eurozone, and while Christine Lagarde continued to rail against any suggestion of a recession, the fact that the Central Bank’s monetary policy decisions are pushing the economy ever closer to the precipice mean that she may have to face reality sooner rather than later.

The facts of global economic life mean that the ECB will have to fall in line with the actions of other G7 members. If Lagarde and her fellow Governing Council members decide that they need to protect the economies of weaker Eurozone members by delaying any further rate increase, they risk not only those same economies being ravaged by high and rising inflation, but also the stronger economies as well.

However, another fifty-basis point increase will hasten a recession, although it may bring inflation down in the medium term.

There are very few traders who believe that there is any alternative path for the euro other than to break parity with the dollar, although there are several outcomes that may be seen in the coming months.

Yesterday, the single currency fell to its lowest level versus the dollar in a week. It reached 1.0154 and closed at 1.0162

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.”