Fears for economy disregarded
17th December: Highlights
- Bank of England again surprises the market
- The word is now Inflation!
- Lagarde leaves the door to a rate hike ajar
Bailey says rate hike was needed to tackle inflation
This month it was a much closer call and as Andrew Bailey said in an interview following the meeting, it is clear that without some degree of action, inflation would continue to rise in the medium term. There are clear strains within the labour market and there are signs of more persistent price pressures.
Bailey spoke of the continuing rise in energy prices and said that the 28% rise in the household gas price was now being exacerbated by the tensions between Russia and Ukraine. With new price caps about to be set, the gas price is likely to add to inflation.
Although the committee showed concern about the effect of the new Covid-19 on economic activity, the balance of risks has clearly led to a need for inflation to be tamed.
Bailey continues to hark back to his view that the inflationary pressures within the economy are primarily driven by the supply side, but the fact that there appears to have been no ill effect on the employment data from the removal of the Government’s furlough support scheme means that the committee felt that the time was right for a hike.
Following the 7-2 vote to leave rates unchanged last month, this month the vote was 8-1 in favour of a hike. The one dissenting voice was that of Silvana Tenreyro. She has been consistent in her view that the economy continues to need support while uncertainty over the Omicron variant remains.
The Bank will be keeping an eye on activity levels as the Government introduces fresh measures to counter the number of fresh cases of the virus. Yesterday saw another record number of cases, although hospitalizations remain under control for now.
The government’s push for people to receive the third, or booster, dose of the vaccine is having an effect with around 750k people receiving it yesterday. Boris Johnson announced a target of one million jabs a day earlier this week and that is expected to be reached over the weekend.
The pound made satisfactory progress versus the dollar following the hawkish actions of both the FOMC and MPC. It reached a high of 1.3374 but fell back a little to close at 1.3324.
Both Central Banks are on a path towards higher rates. The MPC expects to raise twice more in 2022, while the Fed, having accelerated the pace of its withdrawal of support, will hike three times in the New Year.
Buy the rumour, sell the fact
Jerome Powell was clear in his view following the FOMC meeting that to hike rates while they are still getting the size of the Bank’s balance sheet under control would be inappropriate.
Although concerns over the pace of the recovery of the labour market remain, the Fed is mindful of hitting the brakes too hard and undoing the patient approach that it has adopted thus far.
While jobless claims have fallen to a record low recently, Powell wants to see continued progress being made. The latest data shows a slight increase in claims from an upwardly revised 188k to 206k.
The housing market has been one of the more seriously affected sectors of the economy from bottlenecks in supply chains.
Data published yesterday shows that housing starts increased from a little over 1.5 million in October to 1.67 million in November. This number is considered even more positive, given that there is often a slowdown as winter deepens.
Data for manufacturing activity has been one of the more volatile datasets over the past few months, and that trend continued yesterday. Despite improvements being seen in many areas, the flash estimate of manufacturing PMI fell to 57.8 from 58.3.
Industrial production also slowed from 1.7% to 0.05%, while capacity utilization saw a moderate increase.
The tone of the FOMC statement following this week’s meeting was clearly more hawkish, but Powell is likely to now demand patience from the market as the acceleration of the withdrawal of support is allowed to do its job.
There is no doubt that speculation about when the first hike will take place will begin, with the withdrawal of support expected to be complete by the end of Q1.
The dollar index remains well-supported, but the more hawkish investors have divested themselves of long positions looking to re-enter the market at lower levels.
The index fell to a low of 95.84 and closed at 95.99.
As things stand, the ECB can remain in dovish mode
The ECB meeting lowered its expectations for economic growth in 2022 to 4.2% from 4.6% as supply bottlenecks continue to retain a stranglehold on activity.
Growth is expected to be 5.1% this year. That figure has been upwardly revised from 5%.
The Central Bank’s main support tool the PEPP, currently running at EUR 70 billion per month will be wound up by the end of Q1 while its other fund, the pre-Pandemic asset purchase programme will see an increase from EUR 30 billion to EUR 40 billion for just a single quarter to avoid the abrupt drop-off of support that could see an adverse effect on the market.
Although the divergence of monetary policy within the G7 was expected to seal the fate of the single currency, Lagarde left the door to a rate hike slightly ajar.
She believes that under current conditions, a hike in 2022 remains highly unlikely.
However, since inflation is expected to remain above 2% for the whole of next year, and there is still upwards pressure, she freely admitted that a few members of the Governing Council disagreed with the continued dovish policy. Her attitude appears to be never say never.
There have been no secondary effects on wage demands being seen as yet, but according to the Bundesbank, upwards pressure on wages will begin early in the New Year.
There are major concerns in Germany about continued supply of Russian gas as the new Chancellor, Olaf Scholz, is concerned about what the appropriate response would be if Russia were to invade Ukraine.
Scholz is facing his first potential crisis within weeks of taking office in what could be seen as an event that will forge his reputation.
The single currency remains under pressure, but the market does appear to be one way round in its attitude to its future path. If the euro does begin to increase the pace of its fall, eventually, exports will become more competitive and that should arrest its slide in the long term. For now, the target of 1.10 versus the dollar appears to be firmly in the market’s sights.
Yesterday, it rose to a high of 1.1360, closing at 1.1333
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.”