20 May 2022: Reluctant MPC hoping this is it

Reluctant MPC hoping this is it

20th May: Highlights

  • Pressure for windfall tax grows after Sunak promises more for Ukraine
  • Business cycle slowing as lay-offs return to pre-Covid levels
  • Lagarde’s magnanimity boosts euro

Bailey hoping that rate hikes won’t last much longer

Ever since the Bank of England began to hike interest rates, there has been an air of reluctance among MPC members. This is excluding Michael Saunders, who would see a reason to hike rates no matter how deep a recession the economy had fallen into.

It will be interesting to see if any current members of the MPC or even Saunders’ replacement, Dr Swati Dhingra, will be a hawk, although given her credentials, that is unlikely.

The term dovish hike appears to have been coined specially to describe how the Committee votes. Comments made before MPC meetings are often accompanied by figurative hand wringing, and once the announcement a shrug and a sense of inevitability appear to suffice.

There is an expression that is attributed to the rail authorities in the UK, who, in winter, often refer to the wrong kind of snow which defeats their efforts to keep the service running punctually. To be fair to the Bank of England, what it is currently experiencing is the wrong kind of inflation.

Currently, inflation is rising due to several factors, none of which are directly attributable to any activity in the UK economy.

As China began to emerge from the pandemic, it told its energy firms to source as much energy as possible, mostly from Russia, to ensure that manufacturing plants could begin to produce again to ensure economic growth.

The wholesale price of energy, primarily gas, rose exponentially and Europe was forced to compete to avoid shortages through the winter. The Government saw this happening but sat on its hands, not wishing to interfere in the free market, which was free only on the surface.

Then Russia decided to invade Ukraine, and we soon found out the number of foodstuffs that the country relied upon Ukraine to produce and also all the items that come from Russia, that UK wholesalers were banned from buying due to sanctions. Still, the Government decided to help Ukraine, but saw no reason to help the UK.

So now, the economy is shrinking, inflation continues to rise and the Bank of England is stuck in the middle, with the words of the chancellor ringing in its collective ears; Well, you wanted independence.

But that is not strictly true. Surely if a situation arises like now, where the Bank of England’s weapons are ineffective, the problem passes to the Chancellor. But Sunak is lacking in ideas, save a windfall tax on the energy companies, who have recently made significant profits.

In that case, their dividends should rise, and this will cheer those members of the public who have their shares in their pension funds. So, a windfall tax will eventually fall back on the public.

However, those members of the public who are tossing a coin whether energy or food is most needed are unlikely to have pension pots, but neither do they vote Conservative.

While this issue rages on, the pound continues to wither. Over the past three days, Sterling has traded in the same range versus the dollar. That range is, essentially, between 1.25 and 1.2320.

The market remains infatuated with data and its effect on monetary policy across the G7 currently, so we await the next FOMC, MPC, and ECB meetings.

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Manufacturing output much lower

The Philadelphia Fed Manufacturing index is one of the more consistently correct data releases when it comes to future activity in the U.S. economy.

For that reason, its release is closely watched for clues.

The data for May, released yesterday, had very little to commend it other than to say it least it remained in positive territory. In April the index came in at a healthy 17.6 while in May, it fell to 2.6. No one really bothers with what those numbers mean, other than to indicate that manufacturing output was far weaker than it had been at the start of Q2.

This will concern the Fed as it intends to hike rates in the middle of next month by fifty basis points and also begin to reduce the size of its balance sheet by ninety billion dollars a month.

One of the shining lights of the economy recently has been the performance of the employment market. One cloud is beginning to appear on the horizon, and that is the fact that weekly jobless claims are beginning to rise again.

Having been below 200k for several weeks, they rose to 218k in the latest week, while the four-week average is a whisker below 200k, coming in at 199.5k.

While weaker jobs data is a concern for the strength of the economy, it does shine a light on the fact that wage growth’s contribution to rising inflation may be waning.

As mentioned above, G7 economies are racing in an unconventional manner. This doesn’t mean that should the NFP for May be weak when it is released in a couple of weeks, that the Fed may be forced to reconsider. Although, the second fifty-point hike could be the last.

Retail sales are still holding up which is a positive sign to go with the improvement in the state of supply chains.

There are still several shortages being seen in goods being imported from China. This is due to the delayed recovery around the Beijing area from the latest bout of Coronavirus.

The dollar index is in something of a confused state, with dealers attaching reasons to movement rather than the other way round.

Yesterday, it fell to a low of 102.69, closing at 102.78. The long-term support is at 102.50, and a break of that could lead it back below 100.

More hawks to get a say in rate hikes

Having announced that she believes that national Central Bank Presidents, Governors and Chairmen should have more of a say in future discussions on interest rates rather than bureaucrats employed by the ECB, Christine Lagarde has acknowledged that it is the responsibility of those who are actually affected by interest rates who need to be responsible.

Using economic theory in such a fluid and hard to manage economy will never work and could drive the economy to the brink of disaster.

It remains impossible to pin Lagarde down on interest rates, although she is less prone to prevarication when the subject of an expected hike in July is mentioned recently.

If it is left to the Central Bank Heads to make the decision, they will be more prone to pragmatism drive simply by the fact that there are far more nations of the Eurozone whose rate of inflation is above the average and that places them in a position that is often difficult to justify.

Monetary policy, Fiscal Policy and Foreign Policy have all melded into a homogenous mess without a cabinet to decide, or at least explain, what the various policies mean.

In the current situation as the global economy emerges from the low inflation/ low interest rate phase that suited the Eurozone perfectly, confusion reigns, a large amount of the blame for which can be laid at the feet of Ursula von der Leyen, the EU Commission President.

This is a position that the Union has simply failed to get right, almost since it was formed.

Unelected politicians never have policies to defend and as such tend to be fence sitters.

With inflation falling from 7.5% to 7.4% could be a worry for the hawks. Could Lagarde perform another U-turn if it falls again this month and try to defend further support?

Surely not.

Yesterday, the euro reacted positively to a weaker dollar. It rose to a high of 1.0559, closing at that level. Tough resistance is situated around 1.0620, but will take a bout of sustained euro strength for that to be broken.

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.”