1 March 2023: Pill sees Bank cutting pace of hikes


  • Falling energy price may stoke inflation
  • Wall Street banks see linger rate hike cycle that previously expected
  • Nagel likely to back Lagarde’s view in major speech
GBP – Market Commentary

Genuine risk of overtightening

The Bank of England’s Chief Economist Huw Pill spoke yesterday of his belief that the Central Bank may consider slowing the pace of rate hikes in the coming months. He fears that there is a risk of the MPC having an adverse effect on the economy if it continues to hike rates at its current rate.

The Bank’s goal is to slow demand sufficiently to lower inflation without going so far that it leads to a contraction in growth. Given that short term interest rates are a blunt instrument with which to try to bring an element of control over the economy, the size of any hike becomes more important the closer rates come to the neutral point at which they are neither accommodative nor restrictive.

Having raised rates at every meeting since December 2021, the MPC as a whole are cognisant of the fact that rates are now at, or close to, the neutral point.

One of the independent members of the MPC, Catherine Mann also commented yesterday on the state of the economy. She believes that the fall in energy prices may have the effect of stoking inflation, as households will have more disposable income than they had when energy prices were soaring last summer.

As households become more comfortable with the level of their energy bills, the temptation is for them to spend on less basic items. There, is however, a fine line due to the fact that households don’t spend their windfall and instead replenish savings, which will also be bad for economic growth.

Mann is by far the most hawkish member of the MPC. She has continuously voted for fifty point hikes, even as the market has begun to speculate over when the time will be right to pause the cycle of increases to allow a review of the actions taken so far to be completed.

With inflation having fallen for three consecutive months, there is speculation that interest rates are now at the neutral point, and the time to consider their effect on the economy may have been reached.

With little fiscal support expected to be offered in the Budget, it may be time for the Bank of England to switch its focus from bringing down inflation to economic growth.

Despite the Brexit del now being completed, Sterling will still see its largest monthly fall since last September in February. It reached a low of 1.1915 and closed at a 1.2027. Although headline inflation continues to fall, food price inflation reached another high last month as the country faced a shortage of fresh vegetables, which led to supermarkets rationing the sales of several salad items.

USD – Market Commentary

Consumer, FOMC and jobs market to determine soft landing

It is becoming clearer almost weekly that the Federal Reserve is also approaching the point at which short term interest rates are neither accommodative nor restrictive to the economy.

Having raised rates from close to zero at every meeting since last spring, the conversations being had at the six weekly FOMC meetings are becoming more relevant to members’ own overall views or the situation in their own regions.

The membership of the rate setting committee has changed in the past month or so, with the permanent members being joined by Regional Fed Presidents on rotation.

Patrick Harker remains on the committee, but the President of the Chicago Fed, Austin Goolsbee, has replaced Mary Daly from San Francisco, and he is so far an unknown quantity.

There is currently a lot of chatter about whether the Fed can manufacture a soft landing for the economy or whether the pace of rate hikes will continue, driving the economy into a recession, which would be considered a hard landing.

There are two significant drivers that will determine how much further the Fed will need to go. In order to accelerate the pace at which inflation falls, the Central bank will need to pass through the neutral point and use short term rate hikes to slow the economy.

Given the number of unknowns that are currently in play, it will be a difficult decision for Jerome Powell and his colleagues to choose the right moment to pause.

Employment and consumer spending are the two main areas that will headline the Fed’s choice of when to draw the current cycle to a halt. The February employment report due next Friday will be a significant indicator given the number of new jobs created in January, while consumer spending is still patchy and unpredictable.

The dollar index is currently bound by expectations of monetary policy changes not just in the U.S., but in the entire G7. Last month, the index broke a four-month losing streak.

It climbed to a high of 105.36, closing the month at 104.99.

EUR – Market Commentary

ECB hasn’t reached the neutral rate yet

The ECB completes a triumvirate of G7 Central Banks that remain on a hawkish path. It is unusual, but the European Central Bank is currently both the most hawkish and the most open in its advance guidance to the markets of its intentions.

With speculation that the Fed may consider returning to fifty point hikes and the Bank of England unlikely to return to that level, Christine Lagarde the President of the ECB has already informed the market that she will preside over a fifty point hike at the March ECB meeting.

Inflation data is due for release this week, and Lagarde has already led the market into disregarding the size of any fall.

In France and Spain, inflation continues to rise. In France headline inflation rose from 7% to 7.2% last month, while in Spain, over the same period it rose from 5.9% to 6.1%. Later this morning, Germany will publish its own inflation data, while the figures for the Eurozone as a whole will be tomorrow.

Germany is expected to have seen unchanged headline inflation in February. The likelihood that prices rose by 9.2% year-on-year is expected to influence a speech from Bundesbank President Joachim Nagel that will be delivered later today.

It would appear that Nagel and Lagarde are now in lockstep, as the ECB is currently heavily influenced by the views of the German Central Bank.

Overall inflation in the eurozone is either continuing to rise moderately or fall too slowly for the ECB’s liking. The headline is expected to have fallen from 8.6% in January to 8.2% in February. In order for inflation to return to the ECB’s target level of around 2%, there will need to be some significant structural and fiscal changes to take place this year.

Lagarde has already called for individual Governments to lower their fuel subsidies, given the fall in the gas price of 40% since the turn of the year.

Consumer confidence has yet to be positively affected by the fall in energy prices, although some lag is only to be expected.

The euro tried and failed to break the 1.10 level versus the dollar in February and this led to traders divesting themselves of long positions which drove it to a low of 1.0532. It recovered a little to close at 1.0578.

Have a great day!

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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.