23 August 2022: Inflation could hit 18%!

Inflation could hit 18%!

23rd August: Highlights

  • Truss’ plans will lead to inflationary spiral
  • Powell may disappoint markets this week
  • Euro breaks parity versus stronger dollar

GBP – Citibank warns over soaring energy bills

The continued rise in the cost of energy could see inflation reach 18% in the coming months, according to global banking giant Citibank. With the wholesale gas price rising by 25% in the past week alone, inflation would rival the levels last seen in the mid-1970s.

Were workers to demand wage increases to keep pace with inflation, it is also forecast that the Bank of England would be forced to hike interest rates to 7.5%, more than four times the current level.

A few months ago, as the country was optimistically looking forward to emerging stronger from the Pandemic and reaping the benefits of Brexit, such a Doomsday scenario was no more than the stuff of economist’s nightmares.

However, with industrial action spreading from criminal court Barristers to dockworkers, there seems little that the Government can do to halt the spiral into higher wage demand that will fuel inflation even more.

With the central bank already acknowledging that there is a recession on the way, all that can be done is to limit its effect.

Over the past fifty years, recession has meant wholesale job losses, business failures and rising provisions made by banks for bad debts. With the economy already contracting, the depth of the recession will depend on several factors, many of which will stem from the rise of globalization.

In its forecast, Citibank estimates that the energy price cap will be raised to more than £4,500 in January, with a further rise next April to around £5,800. It currently stands at £1,971.

The current energy market forecast is for the January rise to £3,500, but with gas prices now ten times their historical average, it is almost impossible to predict where they will end.

One of the most urgent issues facing the new Prime Minister when he or she first takes office will be to increase the production of gas from North Sea fields that have seen a reduction in line with green energy policy. When faced with economic catastrophe, it is likely that any country’s green credentials take second place.

Today’s release of PMI data is expected to provide a little relief as it is expected that services output will remain in positive territory, falling marginally from 52.6 to 52.

The pound reacted poorly yesterday to another bout of global risk aversion. It fell to a low of 1.1742, closing at 1.1765. That is its lowest close since March 2020 when the country began lockdowns.

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USD – Fed and Market on different pages

The minutes of the most recent FOMC meeting appear to predict that although the Fed will continue its policy of tightening monetary policy, the size of the increments will begin to fall.

However, the meeting took place almost seven weeks ago, and in the current global environment where energy prices are rising exponentially, that expectation is now chronically out of date.

For that reason, the major policy speech that the Chairman of the Federal Reserve makes annually at the Jackson Hole Symposium is taking on a higher degree of importance than normal and is eagerly awaited by the financial markets.

The decoupling of the U.S. and Chinese markets is continuing, with China having cut interest rates recently as its economy falters. Beijing cut the interest rate on one-year and five-year loans, while the Fed has delivered 225 basis points of increases since March, with more to come.

It is unlikely that Jerome Powell will change the core message of current Fed policy. He will continue to support the Central Bank’s primary goal of bringing inflation back close to its 2% target, even if the risk of a full-blown recession increases.

One major difference between the U.S. and China is that the PBOC has room to allow accommodative monetary policy, as its inflation rate remains below the Government’s 3% target.

Jackson Hole has been the stage for major policy announcements in recent years, but it could be something of an anti-climax this year, as the Fed has set out its stall very clearly at recent meetings and remains data driven.

The most fundamental concern facing Powell and his colleagues on the FMC is the continued rise in the headline number of new jobs created.

The latest employment report will be released a week from Friday, and early expectations are for the reticent average to be maintained.

Before Powell’s speech, data for pending home sales and durable goods orders will be released.

The housing market has been showing signs of being affected by higher interest rates recently, but the expectation for pending home sales is for an improvement from the shocking fall of 8.6% in June to a more reasonable (in the current environment) fall of 3.8% in July.

The dollar index has begun a new round of strength driven by a fall in global risk appetite, it reached a high of 109.10 yesterday, closing at 108.96.

EUR – Recession becoming more certain by the day

The continued rise in the cost of energy will add another nail to the coffin of growth in the Eurozone. With no opportunity for nations to replenish stocks as is normal during the summer months, the outlook for this winter is growing bleaker by the day.

The prospect of gas rationing in Germany has gone from possible to probable, with the Government unable to provide sufficient to keep industry functioning and heat the homes of the most vulnerable.

The fallout from the war in Ukraine continues to spread throughout Europe. With the fall in the cost of oil having little or no effect on the rate of inflation, it shows how the shortage of basic foodstuffs has seen prices skyrocket.

No one expected the war to last until now, but with no sign of an end in sight and the harsh winter conditions about to begin to set in, it will be a tough winter across the entire continent.

One bright spark for the wider Eurozone has been the decision to remove the controls that were being exerted over Greece as paper of its post bailout conditions.

Athens has performed close to an economic miracle by managing to sell to its people the need for austerity in its provision of social services. That has led the country into relative financial stability.

In Germany, retail sales fell by 8.8% when compared to a year ago and this is expected to set the tone for the rest of the region. The fall was driven by a combination of scarcity of certain items, coupled with rising prices.

German attitudes contrast with those of the UK where retail sales improved as shoppers decided that with prices rising and no sign of them coming back down, it is better to pay now.

German savings rates also rose by a higher amount during the pandemic as consumers prepared for such an eventuality as is being seen currently.

With the economy faltering badly, there are bound to be questions asked about the ECB’s policy of hiking rates to try to tame rampant inflation. It remains certain that rates will be increased at the next meeting, but then it may be time for a pause.

The euro, as expected, breached parity with the dollar yesterday, falling to a low of 0.9926, its lowest level this year, closing at 0.9943.

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.”