18 September 2023: Mixed signals for the MPC to consider

The Monetary Policy Committee meets later this week to decide whether another hike in interest rate is needed, or if the fourteen that have taken place in this cycle have slowed demand sufficiently for inflation to follow.

Over the past two weeks there have been a series of mixed signals, none more so than the employment report for August.

Wage inflation has now exceeded consumer price increases, which points to a wage/price spiral continuing, but the unemployment rate is starting to increase which is a clear indication that interest rates are now at a level where they are restricting demand.

While it is certain that the five permanent members will vote in unison, there have been some interesting comments from the independent group recently.

Swati Dhingra is of the opinion that not only is a hike not justified at this time, but the cycle would have been halted before now.

Catherine Mann has a far more hawkish view. She spoke last week of her belief that the Bank should err on the side of “over-hiking” to ensure that inflation falls back to the Government’s 2% target, even if it means that the first hike is used to reverse a rise that proved to be unnecessary.

The result of this week’s meeting is a close call, as was the ECB meeting last week and FOMC this Wednesday. That is to be expected as rates come close to being sufficiently high to restrict demand.

Rishi Sunak is approaching the anniversary of his being elected the Leader of the Conservative Party and Prime Minister.

Having spent several months straightening out the mess that he inherited only recently has he been able to press forward with his own policies. So far, the jury is out on his performance and his Party still trails in the polls.

His opposite number, Sir Keir Starmer has embarked on a path which could see that lead dwindle further. The Labour Party has been shackled in the past by the demands made by Trades Unions, who provide significant financial support to Labour are rumoured to be making ever more demands on Starmer for him to adopt radically left-wing policies.

Furthermore, he is considering renegotiating the Windsor Protocol which is the framework for the future relationship with the European Union.

The Labour Party are unable to “leave well alone” and wait to win the election. They are in danger of squandering their lead by frightening the electorate by showing they do not deserve the trust that has been placed in them so far.

Last week, the pound fell to a low of 1.2379 and closed at 1.2384. A lot will depend on this week’s monetary policy committee meetings to see if it will test the major long-term support at 1.2000.

Yet another round of “chicken” is looming for the U.S. economy as the Federal Government is about to run out of money yet again.

This time it is looking likely that with just thirteen days left to find a solution, a repeat of the last shutdown in 2019 will take place.

It is estimated that a shutdown will cost the economy around three billion dollars, although that price tag is beginning to look a little low.

The two sides in this battle have become ever more increasingly entrenched and if a shutdown does occur it could continue for some time. Another thing that is different this time is that so far there has been no “voice of reason” emerging that could bring the issue to a close.

The market expects that if there is a shutdown it could last between two and three weeks, although there is a train of through which considers it lasting for the entire fourth quarter, which would shatter the previous record of thirty-five days.

A shutdown of the Federal Government would be extremely damaging for the economy with only Medicare and social security unaffected. It is estimated that if it lasted more than a month that it would wipe as much as 1.2% off fourth quarter growth.

That will be a consideration for the FOMC which begins deliberations about any proposed change to monetary policy tomorrow, with the vote taking place on Wednesday before Jerome Powell holds a press conference to explain the rationale behind the decision.

Despite the rise in inflation that was seen in August, the committee is still expected to agree to another pause in its programme of interest rate hikes.

In the past, Powell has spoken of the fact that the fall in inflation is unlikely to be linear and with the August rise being entirely due to the rise in gasoline prices, a pause remains justified, particularly in the light of other data that has been published recently.

The monetary policy meetings that are taking place now have been long-awaited and when they are over, speculation will begin about when the MPC, ECB and FOMC will consider a permanent end to their programmes.

The dollar continues to gain support from the relative strength of the U.S. economy. Last week it gained for the eighth consecutive week. It came within a whisker of the high for the year last week and there is little holding it back from another attempt at the 110 level.

Last week, it closed at 105.33 having earlier reached a high of 105.43.

It is rumoured that Christine Lagarde insisted that each of her colleagues on the Governing Council of the ECB relinquished their mobile phones prior to last week’s meeting as she was concerned about the number of leaks of their discussions that have happened recently.

She also rebuked them for leaking crucial information in advance of the vote. It is hard to imagine any members of the Council being able to materially gain from leaking information, but this shows another lack of trust that pervades a group that has become too unwieldy for its own good.

It is understandable that every member State of the Union would want to be involved in the decision-making process, but it has become cumbersome in the extreme.

The issue of leaks has plagued Lagarde for the entirety of her Presidency and was also an issue for her predecessor.

One of the EU’s most important data publications, the August inflation report, was leaked to news services in advance and was thought to have had a significant bearing on the vote that eventually took place to hike interest rates to their highest ever level.

There have been no immediate comments made regarding the hike that came as a surprise to some but was expected by others.

The ECB is now in a difficult and dangerous position. The next meeting, which takes place on 26th October will need to see some compelling news on growth and inflation to justify a further hike.

Lagarde refused to confirm that rates are now at their peak and wouldn’t be drawn on the question of when the first cut will take place.

Although the decision was far from a “dovish hike”, the market failed to be inspired. The common currency fell to a low of 1.0631 and closed at 1.0657. If it no longer has the support of tighter monetary policy, that could be the confirmation traders need for its long-term direction to be confirmed.

The latest inflation report is due for release tomorrow. It is expected that the harmonized figure will remain at around 5.3% as has already been reported, which in some ways justifies last week’s decision.

Spanish GDP data is due on Friday. While this is rarely considered to be a “vital statistic,” given the robust performance of the Spanish economy recently, it could have a bearing on GDP for the entire region.

Have a great day!