22 April 2022: Mann acknowledges inflation risks

Mann acknowledges inflation risks

22nd April: Highlights

  • MPs to investigate Johnson transgressions
  • Speaking at the IMF, Powell retains hawkish tone
  • Rates rising into positive territory this year, a no-brainer

Demand unlikely to fall in time to deter wage demands

The Central Bank meetings that will be held in the first week of May are each going to be crucial in their own right, but combined will set the tone for the financial markets for the rest of the year.

The Bank of England’s MPC appears to be unable to commit to a fight against inflation given the concerns being expressed by some of its members about contributing to a slowdown in the economy which eventually becomes a recession.

Catherine Mann, one of the newer members of the Committee, spoke yesterday of her concerns that rates will have to rise at an even faster rate than is currently being predicted, since the current pace of tightening may not dampen demand sufficiently to stop wage inflation becoming ingrained in the economy.

At the time of the first increase in interest rates in February, Mann voted for a fifty basis-point increase, believing that front loading the tightening of monetary policy would add to its effect. It turned out she was in the minority, and she fell back into line in March when he voted for the twenty-five-basis point increase that was eventually agreed.

The Bank of England, which has been independent of Government since 1997 when the Monetary policy committee was formed, faces both an opportunity and a challenge to cast off its conservatism and act to bring the economy back under control at its next meeting

Andrew Bailey was considered a safe pair of hands when he took over from the Canadian Mark Carney in 2020. He is far more of a technocrat than Carney, who appeared to have a more maverick character.

The Bank of England is still regarded as the model by which other Central Banks are judged, despite the demise of the nation that led the world in several ways.

Mann, one of the more modern members of the committee, spoke yesterday of her fear that inflation will become ingrained in the economy, but also acknowledged that the depressed level of price increases seen over the past ten years or so were unusual, and had to end at some point.

Returning interest rates to what is considered a neutral level is a task the bank has in common with the Federal Reserve, but the U.S. Central bank is prepared to act more aggressively than the more staid Bank of England to get the job done more quickly.

Yesterday, the pound managed to continue its recent, albeit shallow, recovery from its fall below the 1.30 level versus the dollar. It reached a high of 1.3093, but was unable to retain its gains and fell back to close lower on the day at 1.3030.

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May hike now baked in, but what about the Balance Sheet?

Speaking at the annual IMF meeting in Washington yesterday, The Chairman of the Federal Reserve, Jerome Powell took the opportunity to all but confirm the Central Bank’s intention of hiking by fifty basis points at its forthcoming meeting.

There have been several comments made by members of the FOMC over the past few weeks that have indicated their voting intentions, so Powell’s remarks did not come as a major surprise.

He was a little less outspoken about the reduction in the size of the Bank’s balance sheet, since the effect of a significant reduction is yet to be fully comprehended.

It is clear that the withdrawal of liquidity that has been something of a comfort blanket for the market will slow the economy, but it raises two major questions.

The first is more technical in that it is unclear just what effect the size of the increments will have as funds are withdrawn from both the Government Bond market and also by sales of holdings of mortgage-backed securities. The second will be how rising interest rates affect the confidence of consumers.

Powell’s deputy Lael Brainard spoke recently of her expectation that the full intended reduction in the size of the balance sheet would have a similar effect as two or possibly three rate hikes. Unfortunately, if it were to be three fifty basis point hikes, the economy could be slowed to such an effect that a recession which is currently given a 35% chance of coming to fruition would become far more likely.

In his speech to the IMF, Powell spoke of his view that increasing the pace of interest rate hikes may be seen as more appropriate as the Central Bank tries to cool rising inflation before it becomes ingrained in the economy.

Powell, who was heavily criticized for not taking rising inflation seriously enough last summer, appears to have received the message loud and clear that inflation is something that will no longer be tolerated by either the markets or the public.

Following the speeches made in Washington yesterday, the market has a fairly clear view of the Bank’s intentions, and traders will have a little under two weeks to get their ducks in order.

Yesterday, the dollar index continued its recent mild correction. It reached a low of 99.81, but ran into major buying interest below the 100 level and recovered to close at 100.62 following Powell’s comments, which were considered slightly more hawkish than expected.

De Guindos sees QE ending in July

The ECB appears to be coming round to the idea that high and rising inflation in the Eurozone is both detrimental to the health of the overall economy and something that many of the Union’s members believe to be anathema to their own economies.

It was the subject of long debate at the time the ECB was formed how the Bank would cope with adopting one size fits all monetary policy that allows those with traditionally high inflation and loose monetary policy to mix with members to mix with those with the totally opposite intentions.

It may be simplistic to say that the current situation is the first time that monetary as opposed to fiscal policy will be tested, but the ECB has had a relatively gentle ride since the financial crisis threatened the entire structure of the Eurozone, and it became necessary for then President Mario Draghi to make his, now immortal, whatever it takes speech.

Although several countries were forced into measures that made life uncomfortable, they have survived, but rising inflation eats into the very fabric of a country’s living standards and, as was seen in Italy, Spain and other members of the Eurozone, can become ingrained in the nation’s psyche.

Christine Lagarde, to her credit, has stuck to her guns in insisting that support for the economy via QE was more important than a little inflation, but even she sees that rising prices are in danger of getting out of control.

Lagarde’s deputy, former Spanish Minister of Economy Luis de Guindos, spoke yesterday of his belief that the reduction in support will be complete by early July. This ties in to the now widely held belief that the ECB will hike interest rates at its meeting that will be held on 6th July.

While the most recent meeting continued the recent trend of observing activity, the conflict in Ukraine has sharpened the minds of most Europe’s Central Bankers.

There have been dire earnings of the effect of the sanctions that are being placed upon Russia on the economies of several leading EU nations, but as long as the ECB is prepared to be both nimble and prepared to take action similarly to its attitude to the financial crisis, the EU should both survive and flourish.

Yesterday, the euro remained in thrall of the dollar. It spiked to a high of 1.0925 but was unable to sustain the rally, and fell back to close at 1.0841 just ten pips lower on the day.

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.”