20 May 2021: Higher inflation but from a low base

Higher inflation but from a low base

20th May: Highlights

  • UK Inflation doubles
  • Market beginning to fear a tightening
  • Debt mountain creating instability risk

Prices beginning to trend higher

The UK has joined the group of developed economies that are beginning to see inflation point towards an overheating economy.

The difference to the U.S. in particular is that at the height of the first lockdown when the economy was hit hard, the UK economy was one of the worst affected in Europe. It therefore is recovering from a very low base.

The Bank of England will not yet start to be questioned over a change in policy to calm price growth.

Governor Andrew Bailey still sees growing inflation as transitory caused most by supply not keeping up with demand, although the jump in wages seen in yesterday’s employment report will serve as a cautionary reminder.

Clothing and footwear prices were the two unsurprisingly dominant increases adding to consumer prices. First, those sectors saw a seasonally unusual fall in February and the reopening of non-essential retail saw demand grow exponentially.

This week’s data will have done little to dampen the markets enthusiasm over Sterling which is continuing to face up to the dollar when it sees data which threatens dovish Fed monetary policy.

The next MPC meeting will be held on June 24th.This will give members an opportunity to analyse a further month’s set of data.

The vote of Chief Economist Andrew Haldane, who leaves the role after this meeting, will already certainly be cast in favour of a reduction of the bond purchase facility.

It remains to be seen if data that has already been released when added to fresh numbers will persuade anyone else of the dangers of an overheating economy.

The one thing the Bank won’t want to do is tighten policy only to face the need to loosen again should the country face the worst of several possible outcomes in the Autumn.

The pound had held its own yesterday, trading down to a low of 1.4150 but the rather more hawkish than expected Fed minutes pushed it to a fresh low of 1.4104, from which it recovered very slightly to close at 1.4110.

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If pace of recovery continues Fed will begin to talk tapering

The minutes of the latest meeting of the FOMC were released last evening UK time. They showed that despite a united front being presented to the market in private, well, until three weeks after the meeting, there is a degree of concern over an overheating economy.

It will be difficult for the market to disguise its expectation that tapering will begin sooner rather than later as discussions will take place at upcoming meetings.

Investors believe that Fed action will take place as soon as discussions take place as the longer action is left once it is agreed that it is becoming necessary, the harder the pressure on the brake pedal will need to be.

Deciphering the words of FOMC members will be difficult as they took place at a time when confidence was very high that the recovery would be extremely strong.

After close to a month of data that has been disappointing at best, the attitude of several Fed Officials and Regional Fed Presidents may have changed.

Fed Chairman Jerome Powell will at least be exonerated from the criticism that he was falling asleep at the wheel and using a belt and braces approach of Quantitative Easing and loose monetary policy to ensure a solid foundation.

Discussion will continue, not least that the next FOMC but the position is far more balanced now even if the dollar’s recovery post -minutes points to a gradual tightening beginning sooner than had been imagined.

The dollar index rose to a high of 90.28, closing at 90.19. It does seem that the path for the dollar index runs into support around the 89.80 level every time it threatens another major fall.

Eurozone debt rising across all areas of economy

Leading indicators continue to predict a recovery for the Eurozone economy that will be slow but steady. Most observers see the Union as being the last of the major economies to reach pre-Covid levels.

As the recovery begins to take hold, it is becoming clear that concerns over the Indian Variant that are threatening the UK could wipe out another summer for the Southern European nations that rely on tourism for a significant part of their GDP.

As the recovery begins to gain momentum, data has emerged that the recovery in Germany may not be as strong as had first been predicted. He latest estimate is for GDP in the Unions most dynamic economy to be a little over 3% this year.

It is also becoming clear that any forgiveness of bonds that have been purchased by the ECB will be a political rather than financial decision.

An article in yesterday’s Financial Times quotes the ECB as being extremely concerned about the financial stability of the region following the Pandemic.

Both Government and commercial debt levels are rising at such a rate that any financial aftershock could threaten the entire foundation on which monetary union is built.]

Debt to GDP ratios across the entire Eurozone rose from 86% to 100% last year. While the figures for several nations dwarf the latest data, it is a concern that the Central Bank is at a loss about how to bring in any kind of restriction without either leading a county into total collapse or harming the recovery of the entire Union.

Inflation remains a concern in the background, but its effect may not be as dramatic as has been seen in the U.S. primarily since the support provided to the economy has been far less forthright.

Yesterday, the euro, having reached a high of 1.2245 earlier in the day, fell back post FOMC to close at 1.2173

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.”