17 January 2022: Economy grows to pre-Covid level

Economy grows to pre-Covid level

17th January: Highlights

  • UK considering reducing regulations further
  • Economic activity slowing at worst possible time
  • Lagarde vows to bring inflation back to 2% area

Inflation to take time to subside

The UK economy finally reached its pre-Covid level in November. The economy grew at 0.9% in November, which finally allied it to reach the level it was at in January 2020.

Inflation is now the Bank of England’s number one target. The U.S. continues to lead the way in price rises, but the Fed is also targeting inflation going forward. The 7% level seen in the U.S. last month is not out of the question for the UK economy, but the Central Bank is acting to slow the rise by raising interest rates.

There are expected to be another three or possibly four rate hikes this year, but it is questionable if rates rising to end the year still below 2% will do the trick.

Should the rate of inflation reach or even come close to 7% in the UK, it will be its highest level since 1992, at the time that the UK was forced to leave the ERM.

This was at the time before the Bank of England took on sole responsibility for setting interest rates.

The most recent data for cases of Coronavirus show that infections of the Omicron variant are falling, and it is clear that the new variant has peaked. This is certainly true in London and will soon be proven in the rest of the country.

So far in 2022, the rate of increase in house prices is showing no signs of abating. It was expected that once the Government’s support for house buyers had been removed, that prices while not falling would begin to level off. That has not been the case so far. The increase in asking prices is still at its highest since 2016.

The threat of rising interest is not proving to be a deterrent, with rates still likely to be at historic lows for some time to come.

Manufacturing and industrial production which only makes up a combined 20% of UK output were released on Friday. Both showed a healthy increase, with Manufacturing rising by 1.1% versus an expectation of just 0.1%.

Tomorrow sees the release of the December employment report. It is likely that the employment rate in the three months to November will remain at 4.2%, while the claimant count may see another significant reduction.

The pound continued to find support against a weaker dollar last week, although it may be unable to sustain a rise above the 1.37 level for long.

Last week, it reached a high of 1.3748 but fell back to close at 1.3678.

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FOMC facing some tough calls

The rate of inflation in the U.S. is expected to remain elevated for some time as the Federal Reserve throws all it has at the issue, The forest rate hike is expected to be seen as soon as the reduction in additional support end in March with moves to normalize activity with a reduction in the size of the Central bank’s balance sheet expect to follow fairly quickly.

Despite the renewed focus on inflation, the situation in employment has begun to cause alarm. The two latest employment reports have been labelled disappointing, but the fact is that they have begun alarm bells ringing.

With the economy not picking up pace at the rate that had been expected and the supply bottleneck, while improving, is not improving at a fast enough rate.

Omicron is still an issue as far as employment is concerned. Millions of Americans are isolating again with the level close to 2020 levels, workers are also staying off work sick and there is a reluctance to re-join the workforce until Omicron cases are beginning to fall.

With inflation having been a major factor for the workforce for close to a year now, workers are beginning to demand far higher rises in incomes than have been seen for some time.

This will also bring concern to the Fed, since while inflation was limited to the supply side of the economy, the factors causing it could be dealt with as the economy opened up more and grew at a more substantial pace.

Should wage demands begin to follow, the time it will take for the entire economy to return to normal will take significantly longer. Weekly jobless claims are beginning to attract more attention, with the 200k level now appearing to be the bottom for claims. The four-week average is now close to 200k, although continuing claims are still falling for now.

Resident Biden has now completed his first year in office, and no one can claim it has been plain sailing. His majority in congress has been less supporting than expected and there have been major challenges to his nominees for senior positions, not least the re-nomination of Jerome Powell.

The dollar index has been driven lower by an expected New Year’s correction, which has been slowing and may now be ending. While it would be dangerous to predict a one-way path for the dollar, particularly versus sterling given the possibility that interest rates in the UK may rise further and faster than in the U.S., but given policy divergence, it is expected to rebound strongly versus the Euro.

Last week, the dollar index fell to a low of 94.62 but rallied to close at 95.16.

Drivers expected to ease going forward

The German Finance Ministry appeared to be a little more dovish than the Bundesbank is comments made last week are anything to go by.

While the new Bundesbank President was calling on Christine Lagarde to get tough on inflation by withdrawing economic support, the Ministry was commenting that inflation is expected to begin to fall rapidly following the end of January.

2021 GDP in Germany is likely to be close to 2.7%. Production difficulties and Coronavirus have been major factors, while bottlenecks are expected to persist through the first quarter at least.

One concession to the continued elevated level of inflation was to confirm that inflation will remain above the pre-Covid level for the rest of this year.

ECB President, Christine Lagarde, acknowledged the concerns that are being caused by the high level of inflation, and she repeated her vow that the Central bank was doing all it could, within the bounds of current policy, to bring it down.

The next ECB meeting, which takes place on February 3rd, is expected to see a major revolt by the more hawkish Central Banks of the Eurozone, with new Bundesbank President Joachim Nagel, keen to express his concerns over the rising rate of inflation.

Nagel may be more of a technocrat than his predecessor, but that doesn’t mean that his debut on the world stage, will be any less dramatic.

In Italy, another name is now being mentioned as possible President. The centre-right members of the coalition are favouring the return of Silvio Berlusconi to the top table of Italian politics.

Berlusconi is certainly far more charismatic than Mario Draghi, and It is certainly a typically Italian move to promote such a controversial figure.

Inflation data for the entire region is due for release on Thursday, with headline CPI expected to remain close to the 5% level seen in November.

The euro made significant if temporary gains against the dollar last week. It made a high of 1.1482 and closed at 1.1414.

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.”