17 August 2021: UK facing headwinds

UK facing headwinds

17th August: Highlights

  • Increase in pace of recovery difficult to achieve
  • Boston and Minneapolis Fed. Presidents see higher growth despite Covid
  • Euro unlikely to rally even if dollar corrects lower

Pressure on BOE to retain support

The pace of recovery from the Coronavirus Pandemic has slowed a little after the unprecedented 4.8% increase in GDP that was seen in Q2.

The economy is likely to reach its pre-Covid level early in 2022 but it will take significantly longer for the economy to reach where it should have been at this point if the Pandemic hadn’t happened.

Unemployment is likely to become an issue as the furlough scheme comes to an end, while there could easily be another spike in cases of Coronavirus as Winter arrives.

So, the economy is not out of the woods yet and this is a reason for the Bank of England to remain cautious about cutting the support that it has provided via asset purchases.

Inflation is the big concern, despite the sanguine attitude of Bank Governor Andrew Bailey. It is easy to believe that since inflation hasn’t been an issue for many years, it will return to normal as soon as support is removed, that doesn’t tell the whole tale.

The economy is suffering from a supply shortage that has been caused by the unleashing of demand that happened as the reopening began. This is not a phenomenon that is limited to the UK, and the issues facing G7 economies are slowing the global economy.

This week’s data is likely to provide further evidence of the way the recovery is progressing, with today’s employment report for July and tomorrow’s inflation data. Members of the Monetary policy committee are fairly entrenched in their views on the timing of any tapering of support, so a marginal fall in inflation is unlikely to change many opinions.

The cautious approach of Central Banks to the removal of support could see any action delayed, with the next few months’ performance critical to the recovery as fiscal support disappears.

The pound remains driven to a large extent by the performance of the dollar. Yesterday, it fell to a low of1.3828, closing at 1.3844. With the summer lull in full swing, it is likely, but not certain, it will remain in its current 1.3980/1.3760 range for the rest of August.

Considering your next transfer? Log in to compare live quotes today.

FOMC to face dissent over taper as economy slows

The two most recent data releases in the U.S. point to a slowing of consumer confidence. Following Friday’s sharp fall in the level of the Michigan study, The New York Empire State Index also fell significantly.

It is unlikely that this will derail the Fed from its path towards reducing support for the economy, since, as discussed previously the data for both indexes this month are outliers and it will take similar falls in other data for FOMC members to change their stance to a more dovish outlook.

The President of the Boston Federal Reserve, Eric Rosengren, is the latest Regional President to support the reduction of asset purchases in the Autumn.

Rosengren is not a voting member of the FOMC for 2021, but he still carries significant weight given his experience and market knowledge.

He acknowledged that the rise in inflation had been something of a surprise, since the Fed had clearly underestimated the effect of the reopening that has taken place over the past few months.

Logistics firms have clearly become close to being overwhelmed, while global shortages, particularly related to semiconductors, have exacerbated the problem.

Rosengren believes that without action, inflation will remain elevated for some time and could return as a permanent factor when considering inflation.

Hiring should continue to improve, but fears that inflation could become a self-fulfilling prophecy in wage demands and negotiations, remain.

Rosengren has been joined by Minneapolis Fed President Neel Kashkari in calling for support to be tapered sooner rather than later. Speaking on Sunday, Kashkari took on an even more hawkish tone in calling for an earlier than expected taper should employment continue to improve at its current rate.

Kashkari becomes an alternate next year, but Minneapolis won’t be a voting FOMC member until 2023.

The dollar continues to threaten to break higher but lacks the impetus to challenge significant resistance levels versus the Euro and Sterling. Yesterday, the dollar index rose to a high of 92.66, closing at 92.62. It has begun to recoup the losses from Fridays that were driven by the Michigan sentiment report and took the NY data pretty much in its stride.

Lagarde faces continued dissent when to taper

The market has pretty much accepted that the ECB will be the last of the triumvirate of Central Banks to withdraw support for its economy.

However, recent data releases show that at least two of the economies that were expected to continue to struggle have seen a significant turnaround in their fortunes.

Both Spain and Italy have posted far better data for growth in Q2 than was expected, and this may develop into a strong argument for an earlier taper if Q3 continues in the same vein.

It is now well known that with German, inflation rising above the ECB’s target, and other stronger economies likely to follow suit, Christine Lagarde still faces some pressure to become more hawkish, particularly if the picture for the economy continues to improve.

Michel Barnier, the ex-EU Chief Brexit Negotiator, can hardly claim a victory in negotiations with the UK over its negotiations to leave the EU. However, seemingly unchastened, he is planning to run in the French Presidential Election next year as a centre-right candidate.

While the nature of French politics remains fairly radical, he is unlikely to challenge Marine Le Pen, to take a place in the final run-off.

In a speech yesterday, Barnier called for a moratorium on immigration to the Union for up to five years. He added that immigration policy does not work for the Union and certainly doesn’t work for France.

There has been a tussle developing with the UK over immigration, as Home Secretary Patel doesn’t feel that France is doing enough to curb illegal arrivals via the English Channel.

The euro remains pressured by the ECB’s apparent dovish outlook, with traders funding very little reason to buy the single currency. Yesterday, it fell to a low of 1.1767, closing at 1.1779. Until the dollar has sufficient momentum to break the 1.1700 barrier, the single currency is likely to remain range bound.

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.”