BoE risks recession with record hike
Morning mid-market rates – The majors
1st November: Highlights
- Gas price to drive inflation lower
- Economy likely to grow by 1.6% in 2022 but no one cares
- Eurozone Inflation hits 10.7%
GBP – BoE to add further misery with 75BP basis point hike
Speculation is growing that rates will increase by seventy-five basis points to try to lower inflation. This will bring short-term rates to 3%, with another hike likely in December.
There has been severe criticism of the Bank’s policy of gradual rate increases that have taken place at every meeting since last December.
The Central Bank has been increasing rates gradually to not slow growth to such an extent that it drives the economy into recession.
The Bank’s Governor has already acknowledged that the country is heading for a period of contraction growth in any event, so it is curious that they are only planning to increase the size of hikes now.
Committee members have been strangely reluctant to voice their opinion on monetary policy recently. With persistent hawk Michael Saunders term as a member having expired, he has been replaced by the dovish Swati Dhingra, whose first vote was for a hike of just twenty-five basis points.
Three members voted to hike by seventy-five basis points on 22nd September: Jonathan Haskell, Catherine Mann and Deputy Governor Dave Ramsden. They will likely do the same again this week.
There has been little discussion recently about the effect of rates turning neutral with a hike of seventy-five basis points. Still, it is to be expected that confirmation of such a move will magnify its effect as company finance chiefs and households struggle with their interest payments.
Mortgage rates will increase again, placing a further burden on household budgets which are already stretched close to their limit as inflation continues to rise, reaching 10.1% in September.
The UK housing market is already showing signs of a slowdown, and this is expected to be a prelude to slower increases in prices, possibly even turning negative in the First or second quarter of 2023 as well as a dip in activity as homeowners stay put to ride out the storm.
The last time there was a significant fall in the price of houses, there was a substantial increase in negative equity. If that happens again, it will substantially add to recession fears.
The Pound appears capped at around 1.1630 as traders await the result of the MPC meeting. It seems that sentiment is divided between those who expect the MPC to hike by Seventy-five basis points and three who prefer to remain cautious.
A larger hike could see the pound top 1.17, while if the doves prevail, it is unlikely to collapse given the City’s new-found confidence in the Prime Minister.
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USD – Wage inflation likely began to cool in October
Speculation is building that they could hike by 100 basis points tomorrow but temper the market’s angst by announcing a policy review before the next meeting.
Powell has been as hawkish as ever, but with growing rumours of an economic slowdown, possibly reinforced by job data published this Friday, he might be persuaded to provide a little relief to borrowers. They have suffered as headline inflation rates have risen over 8%, despite falling moderately for the past two months.
Although short-term interest rates are well into restrictive territory, there has not been a significant drop in the expected rate of inflation. In fact, the climb into restrictive territory appears to have had a greater effect on output, despite growth having returned to positive in the third quarter.
The ISM manufacturing index will be released later today. It is expected to have fallen perilously close to contraction, reaching 50 following last month’s read of 50.9
As speculation is continuing to grow that the economy is heading for a recession that will begin in the first quarter, banks are expected to begin the prudent action of setting aside a portion of their profits to offset expected loan defaults.
President Biden hinted at a windfall tax on energy companies yesterday as they continue to make record profits. This will assuage the Democrat voters’ fears that the Administration leans too heavily in favour of big business, especially as the Fed Chairman is a Republican.
The Dollar Index continues to move away from the lows made late last week as confidence that the Fed will hike by at least seventy-five basis points tomorrow continues.
The Index rallied to a high of 111.67 and closed at 111.58
EUR – Does Lagarde have a tool for stagflation?
The most significant of those tools, which will allow severely indebted nations to borrow from the markets at spreads relatively close to those that Germany enjoys, has fallen into difficulties.
The only way that Italy, Spain, Portugal, and others will be able to reduce their spreads is if Germany or the Frugal Five do so as a group; which they will be reluctant to do, given the perilous state of their economies and the threat that they may be forced into default as their economies collapse into recession.
A new phenomenon is appearing on the horizon, which, no doubt, Lagarde’s minions are working on: the age-old bogeyman of stagflation.
According to economics textbooks, stagflation appears when an economy is suffering from high and rising inflation and by hiking rates chokes off demand to such an extent that its economy falls into recession.
A further sign of stagflation occurring is high and rising unemployment, which, so far, is not a factor in the Eurozone, although the rate crept up from 6% to 6.6% in August.
Vladimir Putin, the Russian President, has been blamed for causing the forthcoming Eurozone recession and high inflation due to his tactics in retaliation to NATO support for Ukraine.
It follows that until there is an end to the conflict, which shows no sign of abating, the economy of the nineteen nations which make up the Eurozone will suffer.
Preliminary data for inflation in the Eurozone in October was released yesterday. It showed that the headline rose to 10.7 from 9.9% previously. This proved some justification for last week’s rate hike.
Third-quarter GDP data was also released, and as expected, the economy only grew by 0.2% between July and September, down from 0.8% in the second quarter.
The Euro faces strong resistance around 0.9940 for now. It fell yesterday to a low of 0.9873, closing at 0.9876.
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.