18 July 2022: Beating inflation, down to patience

Beating inflation, down to patience

18th July: Highlights

  • Economy shows growth despite raging inflation
  • Netflix numbers to be considered a proxy for U.S. economy
  • Twenty-five or fifty, the debate rages on

GBP – Quelling demand not the answer to modern inflation

Surging inflation and rising interest rates didn’t manage to completely douse economic growth as the economy grew by 0.5% in May, compared to a 0.3% contraction a month earlier.

This unexpected improvement may be explained as an anomaly, but the reason for it has so far not been explained.

With the Government closing, for all intents and purposes, a month early to allow the race for the Leadership of the Conservative Party to take place, Westminster is doing nothing than cheering on its Candidate on one side or promising that no matter who is elected, they will be slaughtered at the next General Election by the Labour Party.

Several candidates have been pressured over how they intend to fund the rather extravagant tax cuts they are proposing. The only one without that pressure is current favourite, Rishi Sunak.

The former chancellor has no need to fund proposed tax cuts as he is not promising any…. yet.

He is providing as much support as he can to the Bank of England which is not only continuing its round of interest rate increases but is likely to move from twenty-five basis point hikes to fifty points at its next meeting which is scheduled for the first week of August.

Construction, manufacturing and services were the main contributors to the increase in May’s GDP number. One other interesting point from the Organisation for National Statistics was that activity in the healthcare sector grew as GP’s saw more patients as vaccinations fell.

That may only be a temporary phenomenon since the Coronavirus virus is on the rise again and this is expected to contribute to the number of people staying away from their workplace.

The Bank of England has hiked five times since December but it has barely made a scratch, let alone a dent in the rise in the cost of living.

While the more volatile items like fuel and foodstuffs have been making the headlines, people are noting rises in everyday items, almost weekly, something

That hasn’t been so prevalent in past times of rising inflation, and keeps the issue at the forefront of people’s minds.

The possibly final ballot of MPs on who they want to be their leader will take place later today, with the result likely to put forward Sunak and either Morduant or Truss.

Last week, Sterling managed to repel a rampant dollar. It fell to a low of 1.1760 but recovered to close at 1.1854, its lowest weekly close since March 2020.

In the coming week, apart from the start of the next stage of the Leadership contest, Employment data will be released tomorrow and inflation on Wednesday. It is expected that core inflation may show signs of topping out while the headline may have edged a little closer to 10%.

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USD – Recession fears waning despite possibility of contractions

The aggressive attitude to inflation that has been displayed by the Federal Reserve since the end of the first quarter is finally having some effect on the level of core inflation. While price rises related to fuel and energy make the headlines, Jerome Powell and his colleagues are more concerned about other two issues in relation to inflation.

The first is how rising wages are being pulled through into the core. The current view of the labour market is that many workers are changing jobs in order to be paid more, since they have realised that that is the only way they can keep up with the current rate of inflation.

Unfortunately, they fail to appreciate that they are contributing to continued price increases and that they will be forced to move again in the not-too-distant future.

This holds something of a hidden danger, since pension rights are severely disrupted and were there to be a significant downturn, the last one in is invariably the first one out.

Supply chains are continuing to improve, but the next issue may well be a fall in demand, which will reduce the burden on the haulage sector but could well be the preface to a significant slowdown.

While that fear has lessened, the results from banks have been pointing in that direction, while the release of Netflix’ second quarter number may also be a significant pointer.

The first quarter showed the first quarterly fall in subscribers in their history, and quarter two may follow the same pattern.

As household budgets are squeezed not just in the U.S. but globally, where Netflix garners a fair share of its revenue, it is the new wave luxuries that are cancelled first. Households will be safe in the knowledge that they can simply unsubscribe and catch up with everything when the nights begin to draw in, in a few months’ time.

Last week, the dollar index made a new all-time high, but failed to push on as the market was undecided.

It is clear that the Federal Reserve will hike, probably by another seventy-five basis points at its next meeting which isn’t until September 21/22, where it will also present its economic projections.

It is possible that the hike could be one hundred basis points, or it could signal a halt to better understand the effect of its actions on the economy.

The dollar index rose to a high of 109.28, but fell back to close at 107.97 as the air around the high got too rarefied for many traders.

EUR – This week’s ECB, a contest between doves and hawks

Finally, Judgement week has arrived!

The Governing Council of the ECB will meet this week and, on Thursday, will announce that it has raised its base interest rate.

That is the easy part.

The difficult question is who will win the inevitable battle of wills that will take place between the doves and the hawks, headed up by ECB President Christine Lagarde and Bundesbank Joachim Nagel.

It is set to be like West Side Story without the love affair! Both sides of the argument feel that they have the interests of the majority of the population of the Eurozone on their side.

Taking the two most prominent nations from each came as examples, Germany has been the economic powerhouse of the Eurozone since it was created, actually holding that position since the sixties. Italy is considered to be profligate and ill-disciplined financially.

Germany expects its population to be responsible for their own finances, saving for rainy days and contributing to their one pension pots. Italy has very little record of saving on a personal level, and continually increases social security to provide for its old and those less able to support themselves.

It was expected that when Mario Draghi took over as Prime Minister that he would bring a level of consistency to Italian Politics.

This can only happen if he is able to convince the other members of the Italian Coalition Government of National Unity to follow. Unfortunately, that has not been the case, and the Five Star Movement which hold the largest number of seats in the Senate has left

Draghi offered his resignation to the President last week, and was flatly refused.

Political turmoil in Italy is as common as it is uncommon in Germany. The departure of Angela Merkel, which would have caused chaos in many states, passed off reasonably peacefully and the election of Olaf Scholz was fairly seamless.

As a prosperous nation, Germany continues to do what it does best. However, although it was able to use its power to quell the credit crisis in 2012, now it is a victim of rising inflation.

If the ECB does not show its claws on Thursday, a faint death knell for the entire Eurozone may begin to toll, very quietly at first, but it will undoubtedly grow louder should inflation fail to be brought under control despite ever more fantastic promises emanating from the Central bank.

Last week, the single currency dipped its toe below parity versus the dollar. It fell to a low of 0.9952, but rallied back to close at 1.0082.

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.”