- Recession fears continue
- Rates will continue to rise well after February
- Industrial Production is beginning to show signs of life
Borrowing rates rising much faster that for savers
In order for a recession to have begun in the fourth quarter of last year, activity would have had to virtually collapse in December. Although there will have been a hit for the industrial action that has been widespread across the public sector, its effect will be seen more in the current period.
It was reported yesterday that despite interest rates rising at every MPC meeting since December 2021, there is a significant disparity in how much borrowers are being charged by major lenders and credit card companies, compared to how much savers are being paid on deposits.
Since depositors have not seen a return on their savings in a decade, they are no longer savvy in searching out the best deals and have simply left funds in non-interest bearing accounts.
At the next MPC meeting which takes place on February 2nd, there is unlikely to be any change in monetary policy unless there is a major surprise in the December inflation report which is being delivered tomorrow.
It is expected that headline inflation will have fallen moderately to 10.6% from 10.7% last month, while the core with volatile items like fuel and foodstuffs stripped out may have actually risen slightly.
This will be a blow to the Bank of England, which has tried to avert any damage to the economy by hiking rates little and often.
Overall, the members of the Bank’s Monetary Policy Committee are split between the dovish outlook from independent members, while those employed by the Bank of England tend to be more hawkish.
For example, Hum Pill, the Bank’s Chief Economist, spoke last week of the need to continue to tighten monetary policy since the UK is facing the usual wide range of challenges but unusually is facing them all at once.
Silvana Tenreyro, one of the longer serving independent members, voted against a hike at the last meeting. Her reasoning was based upon a view that continued rate hikes were beginning to affect the jobs market despite continued tightness.
One outlier of the independent members is Catherine Mann, who is now seen as the most hawkish on either side of the MPC. She voted for a seventy-five basis point hike at the latest meeting.
There is no doubt that tomorrow’s data release will be significant, although it is highly doubtful that it will change any minds on the MPC ,and a fifty point hike is expected on February 2nd.
The prospect of higher rates is one of the few reasons the pound is holding up well on the financial markets. Yesterday, Sterling lost a little ground as the dollar shook off the effect of lower inflation on the market’s view of likely FOMC actions. It fell to 1.2171 and closed at 1.2195. Versus the Euro, it remains close to its medium term low, closing at 1.1270.
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Fears over inflation are not fading
While speculation remains that the FOMC will begin to taper its cycle of interest rate hikes at either the next meeting or the one following, there is no indication that the members of the rate setting committee are feeling the same.
While inflation was rising significantly and the Fed were committed to bringing it under control, it was a fairly easy task to second guess their actions.
However, in an environment where a change in bias is likely, it never pays to second guess a Central Bank’s actions as they retain the ability to surprise the markets in order to get the maximum bang for their buck.
At the next meeting of the FOMC, a whole range of results are on the table, for no hike at all all the way out to a seventy-five basis point hike.
While seventy-five basis points would point to a significant hawkish shift, the fact that it can even be mentioned demonstrates that traders don’t really appreciate the dynamics that are currently in place.
Jerome Powell was more shaken by the effect of his comments on inflation being transitory, which were made some months ago, and this made him appreciably more hawkish than would have otherwise been the case.
It should be remembered that Powell is not a Central Bank by profession like all of his predecessors and is unused to risk-taking in the manner of a Greenspan or a Bernanke. As he sees those more seasoned bankers on the FOMC leaning towards the hawkish end of the rate spectrum, he is naturally swayed by their opinions.
The FOMC as a whole is not yet prepared to believe that inflation has been defeated. The continued tightness of the labour market and the pace at which inflation is falling both leave them inclined to another fifty point hike early next month.
The fate of the dollar is inextricably linked to monetary policy and while inflation is falling, the Greenback will lack any upside potential, and if the FOMC turns dovish there could be a wholesale fall to test 100 level for the index.
Yesterday, as the effect of the recent CPI data wore off, the index rallied to a high of 102.56 and closed at 102.36.
Interest rates are one issue, but not the only one
The use of the Harmonized Index of Consumer Prices is not considered fit for purpose and needs to be revised to better reflect the current situation.
To simply use a blunt instrument like short-term interest rate hikes to control what is a far more complex issue is considered both outmoded and limited in its scope.
The inability of the Central Bank to differentiate between what is perceived to be the danger of inflation remaining higher for longer, versus the reality of the inability of nations to fund their budget deficits, could lead to several nations staring at default.
The hope is that Brussels won’t allow it to come to that, but the influence of the more hawkish nations and their deep concern over the long term effect of high inflation may exacerbate the issue.
There have been signs recently that output and productivity in Germany is beginning to recover from the slump it has seen over the past year or so, and the country may even escape a recession this year.
Interest rates are expected to reach a high of 3.25% early in the second half of the year before the ECB, which will need to be more nimble in its monetary policy changes, considers a cut.
While the UK faces all of its demons at once, the Eurozone is still considering the possibility of a similar experience, despite the fact that it doesn’t face the rigours of Brexit.
There is genuine desire building among traders to tentatively take long positions in the single currency, although they are not showing total confidence yet.
The euro paused for breath yesterday following a significant rally over the past few sessions.
It fell to a low of 1.0801 and closed at 1.0820.
Have a great day!
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16 Jan - 17 Jan 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.