17 February 2022: Inflation at 30 year high

Inflation at 30 year high

17th February: Highlights

  • Poorer every day
  • Fed minutes full of ifs and buts
  • Putin toying with Kiev?

Prices rise by YoY 5.5% in January

The pace of growth in the rate of inflation slowed a little in January, but it still reached a thirty-year high of 5.5%.

It is no surprise that energy costs were the main contributor. With the economy facing further headwinds in the coming months with the increase in the level of the Government’s energy cap and rise in National Insurance contributions, prices are set to continue to rise despite the best efforts of the Bank of England.

Interest costs to UK households are expected to rise by £12 billion this year, with a similar increase likely in 2023 as well. It is unclear whether the Central Bank will hike again at its next meeting.

It is impossible to use any historical precedent, since the economy has both fallen and recovered at a record rate over the past two years.

The country is recovering from the Pandemic and most restrictions have now been removed across the entire UK. However, despite the economy growing by 7.5% in 2021, that included a 0.2% contraction in December.

This was caused by the rise in cases of the Omicron Variant and was before it was discovered that Omicron was milder than the Delta variant,

Is it possible that the Bank of England could slam on the brakes so hard that it causes a recession? If there are further interest rate hikes and business investment begins to fall, that is a possibility, particularly if wage demands are made that match or exceed the current rate of inflation.

Overall, the next two or three months are vital to the health of the economy. The effect of the dual issues facing will slow spending, and this will also prove to be a drag on growth.

Yesterday, the pound remained range bound. It traded up to a high of 1.3600, closing at 1.3593.

Next week, data will be released which shows how activity and output in the services sectors had fared in February. The Bank of England Governor will also be testifying before MPs when he delivers the Bank’s latest Monetary Policy Report.

This may shed some light on its plans for the next quarter, together with its expectations for growth and inflation.

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50bp is now the probable outcome

The minutes of the latest FOMC meeting were released by the Federal Reserve last evening.

The discussion centred around the rate hike that will take place next month, but there was no decisive decision made as the committee looked at the ifs and buts of rising inflation and the expected direction of growth in the economy.

The markets had expected the Fed to supply a more hawkish summary of events that would all but confirm a 50bp hike on March 16, but that failed to materialize.

FOMC member Neel Kashkari took to the wires immediately prior to the minutes being released. He expressed his belief that it is right for the Fed to take its foot off the gas but emphasized the difference between that and slamming the brakes on too hard.

The Minneapolis Federal Reserve President went on to say that more hawkish actions could send the economy into recession. That means that Kashkari is likely to be more cautious than some of his colleagues when it comes to a vote, but it remains to be seen how urgent his colleagues see the need for inflation to be brought back under control.

Kashkari also believes that the Central Bank will agree that a part of the recent rise in inflation will fade naturally, since a rate hike would not address supply side issues that have been prevalent recently.

Retail sales rose by 3.8% in January. This was well above market expectations for a 2.3% increase.

However, it is believed that at least part of this increase was due to the availability of certain items that had become scarce due to the bottlenecks in supply chains that have lessened since Christmas.

Data for Industrial Production showed that activity is returning to normal. Following a minor fall in December, output returned to positive territory in January.

This was despite the last remaining issues with supply chains that are affecting the supply of spare parts and raw materials far more than the supply of finished goods.

The dollar index took the FOMC minutes in its stride, since traders have clearly decided that it is better to adopt a wait and see policy.

It fell to a low of 96.67 and closed at 95.82. It has rallied a little further overnight as first reports of an exchange of fire between Ukrainian and Russian troops come in.

Latvian ECB Member sees rate hike this year

Reports from Kiev yesterday suggested that there is little evidence of a pullback of Russian troops withdrawing from their positions on the border with Ukraine.

There have been reports overnight that there have been minor exchanges of fire but so far there is little further information.

Any escalation of hostilities could prove to be disastrous for the Eurozone economy, with President Putin likely to use the Russian gas pipeline to Europe as a weapon to counter any sanctions that are put in place by the west.

ECB Governing Council Member and Governor of the Latvian Central Bank Martins Kazaks spoke yesterday of his belief that an interest rate hike this year is quite likely.

He said that his stance would be to introduce a phased policy adjustment, and her believes that money market predictions of a hike before the end of H1 are too harsh.

Kazaks believes that rocking the boat by hiking too quickly could lengthen the period before the economy has fully recovered. Kazaks is seen as a moderate on the ECB Council who is prepared to be neither hawkish nor Dovish, but to be reactive to the situation that prevails.

His remarks were slightly hawkish, with the doves holding firm and acting against any expectation of a hike this year.

The euro is caught between events in Eastern Europe and U.S. economic factors.

Yesterday, it rose to a high of 1.1395 and closed at 1.1383. The balance of risks still favours a fall in the value of the single currency in the medium to long-term,

First, any escalation in Ukraine will be bad for the Eurozone, and it is unlikely that the pace of withdrawal of support for the economy will trail other more hawkish G7 countries for at least a year and maybe longer.

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.”