22 April 2021: Inflation begins to rise

Inflation begins to rise

22nd April: Highlights

  • Indicators show UK is well on the way to recovery
  • U.S. in danger of failing its own test
  • ECB to shed light on inflation plans?

BoE unlikely to be concerned… yet

Most indicators are now showing that the UK is recovering from the Coronavirus Pandemic and remains on course to complete the lifting of restrictions as the two final pieces of the roadmap jigsaw are set to be in place over the next couple of months.

While scientists still voice concerns about variants of the virus emerging in other countries, the UK’s infection rate, hospitalizations and fatalities continue to fall.

The turnaround from being the one of the most significantly affected economies in G7 to being likely to be the first to emerge completely from restrictions has its roots in the development of the vaccination.

The work that has been done to ensure its distribution and the willingness of the population to be guided by the science and the Government’s continued urging were also significant factors.

Inflation has become the global bete noire of the global economy with several factors combining to cast a shadow over the varying pace of recoveries from the Pandemic.

The level of monetary and fiscal support that has been pumped into the global economy plus the supply side issues brought about by the release of pent-up demand are beginning to cause concern across the globe.

Data was released in the UK yesterday which showed a significant rise but from a very low base. Core consumer prices rose year on year from 0.4% in February to 0.7% in March.

While this is not news that will concern the Bank of England yet, it will be something that will raise concerns should pressure build for further easing of policy in the Autumn. This ticking time-bomb is something that the authorities cannot do anything more than sit and watch for now while the situation plays out.

The pound continues to flatter to deceive those traders expecting a break of the 1.40 level versus the dollar. Monday’s sharp rally has been followed by two down days. Sterling now looks to be attracting support between 1.3900 and 1.3880.

Yesterday it fell to a low of 1.3885, closing at 1.3926.

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Is the dollar’s fall a deliberate act?

The U.S. Treasury performs a six month review of the global economy, concentrating on which countries are behaving manipulatively in order to gain an advantage through artificial currency weakness.

The threat of action against those countries that manipulate their currency by the use of tariffs to level the playing field has in the past been sufficient to halt such policies. This has led to more subtlety replacing the sledgehammer effect of good old-fashioned direct market intervention.

This was the original source of trade issues between the U.S. and China although Beijing always vowed that the development of the economy required a weaker currency than the market would allow through natural activity. A claim constantly disputed by Washington.

The Treasury in Washington has just released its latest report with Switzerland, Vietnam and Taiwan being the unlikely nations under threat of failing the tests that determine manipulation.

The irony of the latest report is that the tests that include persistent one-sided intervention to weaken the currency and an external deficit of more than 2% of GDP, if applied to the U.S. would see it fail.

The jury is out on whether the U.S. is using its continued stimulus of the economy together with historically accommodative monetary policy to drive the dollar to artificially low levels.

This may have been behind the comments emanating from Beijing over the past few days that have been critical of the U.S.’ continued dominance of the global economy and its self-imposed role of manipulation policeman.

The fact that the recovery of the U.S. economy is likely to be both the fastest and strongest is leading to questions being asked about it growing to the detriment of others.

This may or not be true but either way, Beijing will make sure it extracts maximum benefit from the story.

The dollar index continues to test the downside but there appears to be natural buying interest developing below the 90.00 level.

The Fed’s continued mantra that it has tools to control any significant rise in inflation will be tested should the dollar’s fall gain pace and next week’s FOMC meeting is gaining in significance almost daily.

Yesterday the index reached a low of 91.08, closing close to the low at 91.12.

Services sector surviving on emergency handouts

The latest report on credit conditions in the Eurozone that is released by ECB points to a worrying fact that banks are likely to tighten their lending policies in H2.

This is yet another indication that the group is not ready to even consider a more joined up fiscal union.

The banks have been given every opportunity to clean up their balance sheets by the extension of provisions that must be set aside against bad debts, but successive crises continue to demand that they stand at the forefront of the battle.

With the Central Bank still in crisis mode it has relaxed its policing of the banking sector which it had left to its own devices.

The effect of this will only be seen once the Pandemic abates and the economy begins to get back to approaching normal whatever that looks like.

It seems likely that the ECB may be forced to take more drastic action with the merging of several banks as they continue to retreat back across their own national borders.

Italy is sure to be the most affected with its national banking market in almost complete disarray. It was already suffering from high levels of bad debts before the current crisis came along.

The positive effect on sentiment and confidence brought about by the inserting of Mario Draghi into the position of Prime Minister is already wearing a little thin.

He may very well be the man with a plan that Italy has been crying out for, but that plan may be unpalatable for a nation that wants to continually spend today with little thought for tomorrow.

Given Italian propensity for devaluation and default as two legitimate monetary policies it may still be that Draghi sees a future outside the Eurozone. That would be the ultimate irony given his role as saviour of the euro at the height of the Financial Crisis.

The disinflationary effect of a stronger euro will deserve a mention following today’s ECB Governing Council meeting, but the market is not expecting anything other than more of the same from Christine Lagarde at her press conference.

The euro saw good support around 1.20 yesterday, falling to a low of 1.1998. It rallied a little to close at 1.2035.

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.”