20 January 2022: Bailey worried about pace of inflation

Bailey worried about pace of inflation

20th January: Highlights

  • Inflation continues to rise
  • Yellen praises Biden’s support for the economy
  • Inflation and interest rates a tale of ice and fire

Prices reach a 30-year high

Bank of England Governor Andrew Bailey expressed his concern yesterday about the pace at which inflation continues to rise.

Having already hiked interest rates once, at its meeting in December, the Monetary Policy Committee is expected to agree to three more hikes throughout 2022.

Bailey has two main concerns; first he is worried that energy prices continue to rise, the wholesale price of gas has quadrupled in the past year, and inflation concerns being expressed in wage negotiations.

For now, wage rises are both manageable and fairly limited, but that is certain to change as Trades Unions begin to try to ensure that the pace of wage rises for their members keeps up with rising prices.

In evidence to the Treasury select Committee, Bailey warned that it could easily be the second half of next year before energy prices start to ease back,

That expectation has continued to be extended as markets have come to terms with just how voracious the appetite for energy has become, particularly in Asia.

The price of oil has also begun to rise, but that is more easily controlled despite the price being controlled by a relatively small group.

One common denominator in energy prices is Russia, and this shines a light on the current situation that is developing in Ukraine.

NATO nations have been falling over themselves to supply arms to the former Soviet nation as Russia continues to threaten its border. Russia believes that Ukraine’s relationship with the west makes it into a quasi-NATO member.

Negotiations continue, although a call between Presidents Biden and Putin appears to have done little to calm things.

Shortages remain a concern for the economy according to Bailey’s testimony, with wages in some sectors like HGV drivers as firms are virtually held to ransom.

Following yesterday’s release of inflation data which showed that headline inflation is at its highest level for thirty years, the pound rallied to a high of 1.3648 and closed at 1.3618. The pound is likely to be the only major currency that is able to keep pace with the dollar going forward, since monetary policy is expected to keep pace with tighter policy expressed by the Fed.

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Housing starts point to improving logjam

The effect of tighter monetary policy in the U.S. on the global economy has forced Chinese Premier Xi Jinping to test the independence of the Fed.

China is the most significant lender to emerging economies as it uses dollars, not bullets to try to ensure the supply of raw materials it requires. to fuel its voracious need for growth.

As interest rates rise, those nations heavily in debt to China may start to require additional support as their ability to repay loans diminishes.

That may force Beijing into accepting its global responsibilities, which will turn the tables by allowing the U.S. to sit back and watch.

Xi has spoken this week of the devastating effect that interest rate rises will have on poorer nations. This is a thinly veiled attempt to try to pressure the Fed, but it is doomed to failure.

Powell is unlikely to be distracted in his efforts to bring inflation in the U.S. under control. Powell received criticism from Former President Trump for hiking rates in 2018 as he was blamed for increasing the burden on American mortgage payers.

Under President Biden, Powell is unlikely to face any domestic pressure, as the normalization of monetary policy is now seen as overdue.

Treasury secretary Janet Yellen, someone who is used to seeing the sharp edge of a President’s tongue, has been speaking this week about the success of President Biden’s support for the economy during his first year in office.

She commented that the first vaccine for the economy came in the shape of the President’s $1.9 trillion support package.

She went on to say that the support that has been provided prevented potential economic disaster that was evident as the former President chose to ignore Coronavirus when it first arrived in the country.

The markets will be interested to see whether weekly jobless claims have bottomed out when the data is released later today. 200k appears to be the tipping point for new claims, with an increase to 230k seen last week. Estimates are difficult to make, but analysts see today’s figure at between 210k and 220k claims.

The dollar index appears to be building a solid base rather than making spectacular but unsustainable gains. Yesterday, it gave back some of its gains for the previous day, falling to a low of 95.49 and closing at 95.60.

Inflation likely to breach 5% in December

The Eurozone finds itself on the front line of the rise in gas prices. Concerns are rising about what Russia may do should it feel compelled to invade Ukraine and receive criticism and the threat of sanctions from Brussels.

Eu Commission President von der Leyen has been quiet so far in response to the massing of Russian troops and military hardware on its border with Ukraine.

She has left negotiations to President Biden, considering the issue to be a NATO problem rather than one to be dealt with by the EU.

Biden has said that he expects Russia to go into Ukraine but is struggling to avoid an overly military response.

Biden’s Secretary of State Antony Blinken has been in Europe this week and met with the Ukrainian President for talks on the continuing crisis.

The apparent battle between raging hot inflation and the cool response of the ECB to any change in monetary policy continues to rage on behind the scenes.

Both sides appear to have decided to withdraw somewhat to consider their position ahead of the ECB meeting that will be held early next month.

The hawks have little hope of changing anything in the near term and will concentrate on trying to get the support that will replace the current PEPP in March altered down considerably.

The issue they face is that the economic recovery from the Omicron Variant and the wider Coronavirus Pandemic is sketchy at best. There are very few factors that are constant throughout the entire Eurozone. That makes rallying individual countries under the banner of inflation fighters an issue.

Germany, seen as the main hawk, will be reluctant to either overtly remind the rest of the Eurozone of the financial support it has provided in the past or making any threats about the future.

So far, the issue has been confined to Central bankers and Finance Ministers but it is sure to be a topic at the European Council meeting that will be held in late March.

There is a danger, however remote, that the Eurozone could cause itself irrevocable harm should the issue not be resolved.

A lot depends on the path of inflation between now and then. Christine Lagarde cannot glibly ignore the threat in her quest for growth, while the new Bundesbank President Joachim Nagel will need to choose his words carefully.

Yesterday, the euro trod water versus a slightly weaker dollar. It rose to a high of 1.1357, closing at 1.1345.

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.”