- High food prices keep inflation close to 40 year high
- Economy showing remarkable resilience
- Lagarde reaffirms plan for another fifty point hike
Little help being given to struggling businesses
Having watched the Central Bank hike interest rates consistently since the end of 2021, Small and Medium Enterprises have had to deal with not just the effects on their markets of Brexit, but a cost of living crisis that hits them equally hard as individual households.
They made representations to Downing Street to ask the Prime Minister to intervene on their behalf when the Budget is delivered next month to provide some well needed support.
The January inflation report was published yesterday, and it showed despite the stabilization of energy costs, headline inflation only fell marginally from 10.5% to 10.1% while core inflation fell from 6.3% to 5.8%. The price of staple food stuffs like low fat milk, eggs and pasta rose significantly, while the cost of olive oil alone rose by 40% compared with a year ago.
Despite headline inflation only falling by 0.4% year-on-year, the financial markets believe that it was sufficient to cause the Bank of England to slow or even bring a halt to the current cycle of interest rate rises.
It is felt that a further fifty basis point hike to bring the base rate of interest to 4.5% may be sufficient, although a final hike bringing rates to 5% may be seen as necessary.
With the support provided by interest rate rises expected to wane in the next months, trades felt that sterling could be vulnerable to a fall. It fell yesterday to a low of 1.1989, although it managed to climb back above the important support at 1.20 to close at 1.2033.
Producer prices also form part of the inflation report. These show the cost of raw materials and spare parts at the factory gate. They are also a useful predictor of future consumer prices. Producer prices were 1.1% lower than a year ago, falling from 14.6% to 13.5% and may be the key to the sell-off for Sterling.
Huw Pill, the Bank of England’s Chief Economist will make a speech tomorrow in which he is expected to provide some advance guidance on the Central Bank’s view of the recent data releases and provide a clue, although it will be quite vague about the possibility of a cut in the size of the interest rate hike that will be made at the next MPC meeting.
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Economy slowly emerging from shadow of recession
One dark cloud on the horizon is the expected rise in unemployment, which is a result of continuous rises in the fed funds rate.
The current level of optimism in the economy will make the job of the Democrat Candidates in elections scheduled to take place late in 2024 a lot easier.
President Biden has handled the economy with a soft touch since the extraordinary support at the Federal level during the pandemic was withdrawn.
Although there is little doubt that the level of support, which drew stinging criticism from Republicans, added to the level of inflation which was badly misread by the Federal Reserve Chairman, the actions of Biden’s Treasury Secretary and Chairman Powell have by and large drawn praise from the markets.
Powell, in particular, has not been cowed by several Armageddon scenarios that have been put forward by business and banking leaders as the Fed concentrates and remains committed to bringing the level of inflation down.
In economic theory, leading indicators of economic performance start with growing confidence and are followed by more solid indicators like industrial production, and PMI’s. Data for these numbers have been improving since the turn of the year.
The retail sales data that was released yesterday was significantly stronger than the market had expected. Month-on-month sales grew by 3% following a fall of 1.1%in December.
The Empire State Manufacturing Index also showed a significant increase, although it remains in negative territory. It rose from -32.9 in December to -5.8 in January.
The market is concerned about the FOMC bringing to an end its policy of rate hikes in the coming months, and until there is some clarity the dollar is being treated with a degree of suspicion.
Yesterday, the dollar index rose to the top of its recent range, reaching 104.11 and closed at 103.66 as its rally ran out of steam.
Fifty points in March and probably May too!
Indeed, she was so adamant in her comments that it was felt that the democratic process had been done away with. She clearly gained confidence from the comments supporting higher rates that were made recently by dove-in-chief, Italian Central Bank Governor, Ignazio Visco.
Visco provided cautious support for higher interest rates, provided they are deemed necessary and the fate of inflation continues to fall.
Lagarde provided a little solace to the doves on the Governing Council by intimating that she will support a pause for evaluation following the latest hike and that subsequent decisions will be data dependent.
She went on to acknowledge that although inflation moderated in the flash data for January, price pressures remain, particularly when applied to core inflation.
The cost of basic foodstuffs is continuing to rise as a consequence of the war in Ukraine, but the significant fall in energy prices is to be welcomed.
Lagarde sees risks to growth as being better balanced bow than they were in December, and the fact that the Eurozone avoid a recession in 2022 is welcome.
The ongoing war remains a significant risk, but after the initial concerns, the region is better prepared for whatever the next phase brings.
There will always be those that favour a more rapid fall in inflation, but the Central Bank’s economists believe that there is also responsibility to engineer a soft landing by raising rates at a moderate level.
The final industrial production data for 2022 brought to an end a difficult year for one of the mainstays of the Eurozone economy. A contraction of 1.1% in December was the fourth month in a row that output has fallen, but there is a degree of confidence that any contraction seen in January will be of a far smaller magnitude.
The euro fell to a low of 1.0660 yesterday as the dollar rose to the top of its recent range. The single currency recovered a little as the dollar ran out of steam and closed at 1.0690.
Have a great day!
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15 Feb - 16 Feb 2023
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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.