- Early retirement, not Brexit, is the largest cause of labour shortage!
- Fed likely to move inflation goalposts!
- Is ECB policy just one big bluff?
Pound ready to tumble in 2023
Despite further interest rate hikes being made by the Central Bank, Sterling is expected to fall as the economy slips into a recession and possibly sees stagflation as the rate of inflation levels off but fails to fall in any meaningful way.
There have been very few benefits that have been apparent from the country’s decision to leave the European Union, with small and medium businesses still tied up in the red tape that has, if anything, been worsened by the mish mash of agreements that place them at a severe disadvantage to their EU domiciled competitors.
That is unlikely to change much in the coming year, as the Government remains unclear about how it handles the flow of goods into Northern Ireland.
One of the reasons inflation has continued to rise is the continued lack of workers. This is partly due to Brexit as EU nationals who used to work in agriculture and leisure have departed for their home countries, but also due to an exodus of employees from the workforce who have decided to take up offers of early retirement.
This follows the effect of the pandemic. The number of people of working age, who are not either working or actively looking for work, has fallen by in excess of 500k this year.
This has made the employment reports give a false impression as the data doesn’t currently include those not actually looking for work as they are not classified as unemployed.
Unemployment is likely to rise in the first half of the year as the economic activity falls. Only a very minor rise of around 0.2% has taken place in the current quarter, with the rate reaching 3.7%.
In historical terms, this is exceptionally low, with the average of 6.75% of workers claiming benefits between 1971 and 2022.
The all-time high is 11.90% that was seen in 1984. While those numbers are likely to be challenged, a rise in the rate of unemployment has a double edge effect. The number of taxpayers is reduced while benefit payments increase.
The current wave of strikes is set to continue well into the first quarter of 2023, with the Government adamant that the offers that have been made to nurses, ambulance crews, rail workers, and postal staff, are fair, just and in line with independent reviews.
The pound remained in holiday mode yesterday, as traders found little reason to push the Market out of recent ranges. It traded between 1.2223 and 1.2085, closing at 1.2174.
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Inflation target may be increased to 3% or even 4%
While the headline inflation has begun to fall as the price of a barrel of oil has fallen from a high of a little over $123 to just above $75, core inflation remains stubbornly high.
The headline rate will always be more volatile due to the fact it reflects the effect of unpredictable markets that have several drivers that are outside the Central Bank’s control. Housing markets are not part of the inflation calculation, while rental payments are. While this removes a degree of volatility, it also makes them slow moving and less subject to economic shocks.
The Federal Reserve is tasked with conducting monetary policy, so as to promote effectively the goals of maximum employment, stable prices and moderate long term interest rates.
Recent unemployment data is skewed by the Pandemic, but the highest rate in the past thirty years was in 2010 when the effect of the financial crisis pushed it to 9.63%.
Historically, anything below 5% unemployment was considered as close to full employment, given the number of adults who weren’t looking for work. However, over the past five years that has been disproved as the rate has remained for the most part below that watershed level.
The Fed is struggling with the 2% inflation target, which has been in place since 1996. The systemic changes in the global economy have made them question if this shouldn’t be raised.
After an era of historically low interest rates coupled with low inflation, the FOMC is considering putting forward a fresh target, possibly as high as 4%, although it is expected they will only raise it moderately to 3% after discussions with the Treasury and Administration.
The Markets are unable to show any enthusiasm to move the dollar index out of its recent range before the end of the year. It traded between 104.78 and 103.77 yesterday, closing at 103.97.
Rate hikes through H1’ 23, will cause significant fallout
Initially, it was felt that this was a compromise between the hawks who were pressing for seventy-five points and the doves who wanted rates to remain unchanged or if it was considered a rise was absolutely necessary, then it should be no more than twenty-five basis points.
The reaction of Italian politicians was in keeping with their national characteristics, it was both explosive and expletive laden.
Italy is currently suffering more than any other member of the Eurozone. It has a new Government that was elected on the back of a programme of social reform that is widely considered to be difficult to achieve without increasing the country’s debt to GDP ratio to unmanageable levels.
Italians shrug off inflation as a natural part of the economic cycle and have lived with rising prices for decades. While their plans for increases in welfare payments will place them at odds with the European Commission and their right-wing Government will make a lot of noise, ultimately the row will be settled as both Brussels and Rome are like a warring married couple; can’t live together but can’t live apart.
The rest of the more indebted nations, Spain, Portugal and Greece, among others are just accepting high inflation and tempering public expectation.
However, if the ECB continues to hike rates, and they begin to bite, the volatile natures of Southern Europeans will bubble to the surface very rapidly which could see the political landscape change rapidly.
For now, a relatively stable but weak currency is attracting tourists to return following the pandemic,
Yesterday, the single currency reached a high of 1.0658 and closed at 1.0615.
Have a great day!
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20 Dec - 21 Dec 2022
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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.