Bank hands baton to the Chancellor
21st March: Highlights
- Will Sunak tackle the Cost-of-Living crisis?
- Economic Cold War will outlast the conflict in Ukraine
- Lagarde still doesn’t recognize the threat of inflation
Sunak under pressure yet again
It is likely that inflation may have reached 6% last month as supply chains continue to creak and the price of energy continues to rise.
Globally, the era of low interest rates has ended, with only the ECB bucking the trend.
The Bank of England having hiked for a third consecutive meeting has sent out a message to the Chancellor that it has done all it can for now, although several observers will disagree, and it is time for the Government to wade into the cost-of-living crisis which could lead to a disaster.
Three rate hikes in a row would usually have had some effect on inflation, but these are far from certain times.
Coronavirus infections continue to dog workers, with hospitalizations on the rise again, although the cases are not as serious as earlier bouts of infections.
Next month National Insurance payments will increase and the raising of the cap in energy costs will see average annual bills rise by close to £1,000.
The Chancellor had been planning for the Spring Budget to outline his plans for bringing the economy back to an even keel but that is clearly not going to happen just yet.
The Prime Minister has apparently been pressuring Sunak to cut the VAT on energy prices, in particular the price of petrol and diesel on the forecourt.
A windfall tax on the profits made by energy firms has also been discussed, but that would most likely be used to replenish the country’s coffers than be passed on to the consumer.
The country is in an economic fix right now although a recession is seen as less likely than in other G7 countries since despite the price of energy having risen and continues to do so, the UK energy reserves should allow the country to survive any global shortage due to the sanctioning of Russian supplies.
With employment data still strong, both the Bank of England and the Chancellor will be concerned that inflation that has so far been limited to the supply side of the economy will spill over into wage demands. That could lead to a wages/prices spiral and bring stagflation.
Last week, the pound staged something of a rally following three consecutive negative weeks.
It rose to a high of 1.3211 and closed at 1.3177.
Next move is trickier to predict
The level of advance guidance that was supplied to the market made the hike itself certain, but also the fact that it would be only twenty-five basis points.
Before the conflict in Ukraine began, there had been plenty of hawkish comments from FOMC members looking to front-load the hike, to not only get the new cycle off to a positive start but also to give the market a jolt into understanding how serious the Central Bank is about tackling inflation.
One of the more outspoken members of the FOMC is Neel Kashkari, the President of the Federal Reserve Bank of Minneapolis. Kashkari sees the Fed Funds rate at between 1.75% and 2% by the end of the year, and he believes that the neutral rate is 2%.
If inflation is still an issue, which appears more than likely, Kashkari believes that the FOMC will be forced to exceed the neutral rate to finally unwind the inflationary dynamics that may remain in the economy.
As rates continue to be increased throughout the year, the Central bank will receive far more information about the necessary path of rises and may need to increase to fifty basis points.
One of Kashkari’s colleagues on the FOMC, Christopher Waller, who is a member of the Governing Board commented that the data seen recently is screaming out for fifty-point increments, the geopolitical situation means caution is necessary.
Waller’s words have been a warning that as and when the situation allows, the Bank will begin to speed up the normalization of interest rates.
As had been predicted, last week’s hike in interest rates did nothing to provide strength to the dollar. The dollar index rose to a high of 99.29, but was unable to sustain the rally, and it fell back to close at 98.22.
Russian sanctions mean problems for the Eurozone too
Last week, she spoke of the need for flexibility on the part of the bank to enable it to react to changes in the outlook.
That idea will jar with the Bundesbank and other more hawkish Central Banks throughout the Eurozone, which believe that rising inflation is becoming Public Enemy Number One.
The need for support for those weaker economies is considered by many of the hawks to have now run its course.
Protecting the single currency is paramount in the eyes of Joachim Nagel, the relatively new President of the Bundesbank. While Nagel isn’t as outspoken as his predecessor, he remains a force for monetary discipline. While Lagarde may talk of channeling her inner Draghi to protect the currency at any cost, she does not truly see the devaluation created by high and rising inflation yet critical.
She believes that the next few months allow the ECB a little wiggle room in which to continue to buy assets to support the weaker economies.
She fears the day when asset purchases stop, and the market is allowed to price assets at their true worth without the Central bank as a backstop.
At some point in the future, the ECB is going to have to unwind its balance sheet size, although there are those who see its currently vastly inflated size as becoming the new norm.
Fitch ratings commented on Friday that the conflict in Ukraine, similarly to the Coronavirus Pandemic, is an external shock that will resonate throughout the entire Eurozone, but its effect will differ across individual nations.
With Russia supplying 23% of oil and related products and 38% of natural gas, the worries for the European Union are real and growing.
Last week, the Euro rose to a high of 1.1137 and closed at 1.1051. Market sources believe that it is unlikely that the single currency will be able to maintain sufficient momentum to break above the 1.1250 level until there is a positive and assured advance in the peace process between Russia and Ukraine. For now, both sides accuse the other of making unreasonable demands.
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.”