16 December 2022: Rate of hikes to slow


  • MPC still wants to beat inflation
  • Retail sales contracted in November
  • The hawks winning the battle… for now
GBP – Market Commentary

Contracting economy is catching up with inflation concerns

The Bank of England raised short-term interest rates by fifty-basis-points yesterday, bringing the base lending rate to 3.50%. From the votes cast, it is clear that there is a diverse range of views among committee members.

Catherine Mann sees inflation as the most significant threat to the financial stability of the economy and voted for a seventy-five-basis point increase. Silvana Tenreyro and the newest member of the MPC, Swati Dhingra both saw a recession being made worse by higher interest rates and voted to leave rates unchanged.

Analysts believe that it is healthy to have a variety of views on the committee, provided they remain relative to the current situation and are not synonymous with a hardened view of economic policy.

In her three meetings to date. Dhingra has now voted for a lower hike than was agreed on every occasion. Her ballot may now be considered as a protest vote, and be disregarded by the market as she is considered out of step.

The nature of Governor Andrew Bailey’s statement following the announcement was more dovish than has been seen recently. He is clearly concerned about the rate of inflation which is showing no signs of materially slowing yet, and he believes that it is vital that the Government remains firm in negotiations with public sector workers pay demands, but feels that inflation will begin to fall gradually, while the economy has entered a potentially damaging recession.

The ongoing strikes by rail workers, nurses, ambulance crews, and firemen have been headline-grabbing and there is a groundswell of support growing for the nurses pay-claim despite the Chancellor and Health Secretary that it is unaffordable.

Since the Bank of England began to raise rates at its final meeting of 2022, they have gone from an eminently accommodative -0.10% to the current level of 3.50% which many observers believe is restricting demand and contributing to the economic slowdown.

With rates ring in several G7 countries, it is clear that Central Bankers want to be seen to be tough on inflation, but with inflation possibly coming close to topping out, is the time approaching when a less aggressive approach may be warranted?

Sterling lost ground against both the dollar and euro yesterday as Baileys was considered to have been less hawkish in his remarks than either the FOMC or ECB, both of which have also hiked by fifty-basis-points this week.

Against the dollar, the pound fell to 1,2156 and closed at 1.2178, while it fell to a low of 1.1456 and closed at 1.1461 versus the euro.

USD – Market Commentary

Economy to slow, but there is enough fat on the carcass

Federal Reserve Chairman Jerome Powell appears to have been in a quandary about how to portray just how serious he and his colleagues on the FOMC are about ensuring that they defeat rising inflation despite it appears to be beginning to fall.

Following the minutes of the previous meeting, Powell made a speech in which he was portrayed as having lowered his hawkish stance and becoming concerned by a slowdown in the economy.

In his statement following the FOMC meeting, Powell again appeared to be favouring a pivot by the Central Bank, as the vote was certainly less hawkish, agreeing a hike of fifty-basis points, while the previous meetings had pushed rates hard into restrictive territory with hikes of seventy-five basis-points.

A few months ago, the Bank appeared to have been content with rates rising to, and remaining at 4%. That attitude has changed, and now they appear headed for 5% with little chance of a reduction in 2023.

Central Banks have made a significant comeback as arbiters of the global economy this year. This followed a number of years of benign neglect, in which rates remained low and inflation was of no consequence. The Coronavirus Pandemic and the first war on European soil in more than seventy-five years brought them out of their slumber

Data for retail sales in November was released and went some way to explaining the concern shown by the Fed about the strength of the economy.

They fell by 0.6 last month, compared to a 1.3% increase in October.

However, weekly jobless claims showed an improvement over the past few weeks, falling to 211k after rising to above 230k recently.

The dollar index recovered some ground that had been lost recently, as the market saw recent comments from Central Banks as mildly supportive for the Greenback.

It rallied to a high of 104.88 and closed at 104.60.

EUR – Market Commentary

Christine Lagarde sees significant rate increases to come

There has been no change to the market’s view that the ECB was tardy in beginning its tightening of interest rates. Yesterday, the Governing Council voted to increase short-term rates by fifty basis points, while there were calls from the Central Bank of countries with weaker economies for hikes to either pause or be restricted to twenty-five basis points.

A smaller hike or a complete pause would have seen the single currency collapse completely, as it would have paid no heed to the concerns of the stronger and more powerful economies of the Eurozone that are suffering extreme concisions and probably favoured a seventy-five-point hike.

There has been some data released by the European Commission that paints a confusing picture of the state of the entire economy.

When it is brown down into individual nations, there is definitely a two paced economy emerging and potentially a third and fourth paced as well!

Germany and Austria as well as Belgium, the Netherlands, Finland and Denmark are prepared to sacrifice growth on the altar of lower inflation, while France for now occupies the middle ground; they have moderate inflation (by comparison) but are unlikely to suffer a recession. The Baltic States are suffering incredibly high inflation, but their economies are growing at above trend.

To try to agree on a level of interest rates to suit all comers is an impossible task. In her comments following yesterday’s meeting, the ECB President, Christine Lagarde, set a target for short-term interest rates to reach restrictive territory as soon as possible.

She went on to say that she envisages rate hike to be a feature of meetings for at least the entire first quarter of 2023.

The market reacted negatively to its perception that the doves had won the day and a fifty-point hike was something of a compromise, despite rates being expected to continue to rise.

It fell to a low of 1.0592 and closed at 1.0625.

Have a great day!

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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.