1 March 2022: Inflation unlikely to fall quickly

Inflation unlikely to fall quickly

1st March: Highlights

  • Inflation rising as fuel pump prices reach £1.50 per litre
  • Economic outlook clouded by invasion
  • Stagflation fears rising

BoE could be unable to hike for a third time

Despite the Bank of England’s new-found determination to bring inflation under control, prices are continuing to rise and will continue to do so for some considerable time to come.

Having hiked rates twice already, it would be normal for the MPC to hold back on a third hike to give the earlier action time to have an effect. However, the pace at which prices have been rising coupled with both the tax increases and increase of the energy cap means that the bank doesn’t have the luxury of time.

The conflict in Ukraine has also added urgency to the situation, as the price of a barrel of oil hovers around $100. Russia’s invasion of Ukraine will be the first global issue that the UK will be reacting to independent of the EU. Since Brexit, the country is now free to establish its own parameters for sanctions, without being guided by Brussels.

London has easily the highest number of Putin allies owning property and businesses, so it is important that the British Government is able to exercise its independence in ensuring they do not slip through the net

While the Russian President clearly took the risk of sanctions into account when planning the invasion, the economy is already feeling their effect. The Rouble has collapsed and there has been a ban on foreign currency transactions being undertaken by individuals. Interest rates were doubled to 20% yesterday in an effort to stave off further speculation.

Russia has around $475 billion in foreign debt, and there is a real possibility that they will be forced to default.

This week is particularly slow for the release of UK data. There are no major releases due, so the pound will be reactive to the global situation.

Yesterday, it continued to recoup some of its losses from Friday. It rose to a high of 1.3431, closing at 1.3413. The Bank of England’s more hawkish stance on inflation should see the pound receive some benefit, and the strong support around 1.3360 should hold firm.

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Fed still undecided on rate hike

Atlanta Fed President Raphael Bostic is considered to be neither a hawk nor a dove among FOMC members. He has a reputation for considering each situation that arises on its own merits.

It is therefore significant that he spoke yesterday of his desire for a 25bp hike when the FOMC meets on 16th March to vote on the size of the coming rate hike.

A few of his colleagues believe that a 50bp hike is necessary to provide markets with a jolt to make them understand that the Central Bank is serious about bringing inflation under control.

Bostic believes that the Fed needs to show itself to be forceful and committed. He sees the major issue affecting inflation as being in the supply of labour, and until the Pandemic is over that will continue to be the case.

He commented that his favouring of a 25bp hike is not set in stone, since there are more data points to be seen between now and then and the Feds understanding of the economy is changing almost on a weekly basis.

President Biden will deliver the State of the Union address this evening. He is expected to concentrate primarily on domestic affairs, but is sure to have a good deal to say about the conflict in Ukraine.

The situation in Eastern Europe is still critical and while the Ukrainian people are to be congratulated on their ferocious resistance to the Russian invasion, the superior firepower and manpower available to President Putin is likely to prevail.

No one really knows what the Russian President’s endgame is, so the resistance of the Ukrainian army is vital to slowing the advance on Kyiv.

President Biden has instructed the Treasury to do all it can to stop Russia from being able to defend the Rouble. Joint efforts are being made to ensure that the Russian Central Bank cannot sell USD, GBP, EUR or JPY in order to defend its currency.

Yesterday, the dollar index steadied following two volatile days at the end of last week. It fell to a low of 96.62 and closed at 96.71. With Jerome Powell’s testament to congress and the February employment report still to come this week, volatility is likely to return.

Russia could default on $478 billion of debt

As a means of securing its future, Ukraine yesterday applied to join the EU. This will have done nothing to allay the demands of President Putin around NATO and will not be considered until the conflict is over. Nonetheless, it is a positive and bold move by the Ukrainian President.

Fabio Panetta, a former Governor of the Bank of Italy and a current member of the ECB’s Governing Council, spoke yesterday of his concerns of the destabilizing effect of the conflict in Ukraine for the EU.

Panetta called for the Central bank to approach the recovery with a light touch. Any steps that are taken should be done with due consideration. Panetta favours the approach being taken by Christine Lagarde and being Italian, is less concerned by inflation than he is with continued recovery and growth.

He went on to say that output and economic activity are being adversely affected by the ongoing conflict.

He believes that removing accommodation too quickly could lead to turmoil in the markets. This is a reference to the ECB halting its purchase of Government debt where, over the past few months, it has become the only buyer, and this is holding prices at levels close to where they were pre-pandemic.

Should that support be withdrawn, prices would collapse and the borrowing costs for several nations, including Italy, would move significantly higher.

The economic situation in Russia is deteriorating quickly, with growth expected to fall dramatically, while inflation soars into double digits as sanctions begin to bite. There is a real possibility that the country will default on its external debt, a substantial portion of which is owned by EU institutions.

The euro is expected to remain under severe pressure, although somewhat ironically, its fall may be tempered, short term, by the size of its presence in the basket that makes up the dollar index.

Yesterday, the single currency rallied moderately. It reached a high of 1.1246 and closed at 1.1210. It is likely that any rally will continue to be capped by selling interest based around the 1.1250 level as the market considers it only a matter of time before there is a test of the 1.10 level.

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.”