21 September 2022: BoE focused on lowering inflation

Bank tanking UK economy

20th September: Highlights

  • The Bank of England tipped for the biggest hike in thirty years
  • Predictions that rates won’t quell inflation but will ruin the economy
  • Germany is facing recession and double-digit inflation

GBP – Calls for the Central Bank to moderate rate increases

Several prominent commentators have joined together to criticize the Bank of England’s actions in continuing to hike interest rates.

They believe that neither the drip feed of rate increases nor the larger increase that is expected to be announced this week will have a material effect on inflation given the fact that demand is not significantly out of control and rising inflation is linked to supply issues that are less affected by monetary policy.

Furthermore, they believe that the Central Bank is running the risk of driving the economy into a position where a recession is not only inevitable but will last for longer than has been predicted by the Governor.

Andrew Bailey has become a prophet of doom for the economy acknowledging that inflation will continue to rise as energy bills increase next month, while commenting that there is little the Bank can do to avert a recession which is expected to last five quarters, starting in the final months of this year.

The Cabinet of new Prime Minister Liz Truss believes that a recession can be averted by stimulating the economy via fiscal policy.

The Chancellor, Kwasi Kwarteng will present a mini budget this week in which he is considering doing away with the national insurance increase that was introduced by Rishi Sunak as recently as last March. Apparently, this proved highly unpopular at the time and was only accepted following a threat from the previous Chancellor that he would resign if he was voted down.

In the end it was only a matter of months before Sunak jumped ship anyway, which led to the collapse of Boris Johnson’s term as Prime Minister.

Following yesterday’s funeral for the late Queen, the country is likely to experience a downturn in economic activity which will see GDP contract in the third quarter of the year.

It is difficult to imagine the Bank of England joining other G7 Central banks in delivering a seventy-five-basis point hike, but most banks believe they will in order to protect the pound.

Last week, the pound fell to a thirty-five-year low at 1.1350 but recovered to close at 1.1420. Yesterday it steadied closing at 1.1430 a little but still remains weak.

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USD – Fed likely will continue to push well above neutral

The perception of several observers is that the Federal Reserve is driving the economy perilously close to a damaging recession raising by seventy-five basis points at successive meetings.

Jerome Powell, The Chairman of the Federal Reserve has turned into an inflation hawk following his assertion that inflation was simply a by-product of the support that the Administration was pumping into a niche economy to stave off the effect of the Pandemic.

He maintains that the latest increase in interest rates is not having a significant effect on stock markets. While this is true, there has to be another reason that Powell is continuing to ignore.

That reason is the continued inflated state of the Fed’s balance sheet and the volume of money that remains in the system.

The highly regarded economist Mohammed El-Erian believes that stubbornly high inflation despite the Fed hiking rates by seventy-five basis points for the third consecutive meeting this week and falling employment will lead the country into recession.

He expects the Fed to lower its expectations for growth as soon as this week’s meeting.

Goldman Sachs has lowered its forecast for full year 2022 economic growth from 1.5% to 1.1% while also predicting that interest rates will climb to between 4% and 4.50%.

The twin blows of rising inflation and rising unemployment will lead the country into a period of stagflation which once it takes hold can be very hard to reverse.

The FOMC meeting which begins today is almost certain to raise interest rates, while there are some economists that are predicting a full one per cent increase.

The Central Bank is determined to return inflation to its 2% target and Jerome Powell has labelled price stability as the bedrock of the economy.

The dollar had a strong week as speculation grew of a seventy-five-point hike. It reached a high of 110.26, closing at 109.64. So far this week, it has tried to remain above 110, but has seen sustained selling pressure.

EUR – Inflation will drive recession by year end

With its economy being devastated by the ongoing energy crisis, the Eurozone is expected to continue to hike interest rates well above the neutral level.

Having had accommodative monetary policy for a considerable time, several members of the group have gambled heavily by borrowing sums that would have seen then sanctioned by Brussels for breaking the 3% budget and seeing their debt to GDP ratio continue to climb.

The overall debt to GDP of the entire eurozone has moderated slightly from 95.7% to 95.6% but it is up from 87.8% since 2020.

The ability of eurozone members to service these debt levels will be a major talking point as interest rates continue to increase and the economy slows.

The lady who is in pole position to become Italy’s Prime Minister, Giorgia Meloni, has pledged to keep Italy’s budget deficit under control, thus avoiding sanction from Brussels, but her policies appear to tell a different story.

She is in no hurry to adopt any of the structural reforms recommended by the Eurozone Italy has to defend its national interests is a favourite rallying call of her Party, The Brothers of Italy.

Brussels believes that Meloni’s policies will lead to Italy backtracking on reforms that are considered vital not just to its economy, but also the economy of the entire European Union.

Italy is demanding more leeway over fiscal rules, and it is feared that should she feel that she has a mandate from the people Meloni could act arbitrarily.

The Chief Economist at the ECB, Philip Lane, believes that the Central Bank will have little alternative but to hike several more times in 2022 and early 2023. The Central Bank has entered into a process of bringing rates up to what will be considered normal levels.

However, what is considered normal will differ quite widely between nations of the Eurozone. The average expectation is for rates to reach 2.50%, but it is unlikely that will see inflation back close to the 2% target.

The euro is continuing to recover based on interest rate expectations. Last week it reached 1.0198 but fell back to close at 1.0017. So far this week, it has drifted around parity.

Have a great day!

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.