23 October 2023: Bailey expects “significant” fall in inflation this month

No matter who wins the next General Election, the UK needs to embark on a major programme of infrastructure renewal. The country’s transport network is creating multiple concerns ranging from a poorly maintained motorway system to a railway network that has suffered from underinvestment since privatization.

The scrapping of the northern leg of HS2 has been the headline maker but is considered just the “tip of the iceberg” in the considerable urban decay that is currently taking place according to a rapport published last week.

The fall in public spending has seen investment fall to its lowest level in more than ten years, and if it is allowed to continue, the damage may become irreparable.

The Next meeting of the Bank of England’s Monetary Policy Committee takes place next week and with the Bank’s Governor, Andrew Bailey, speaking last week of his confidence that inflation will have fallen this month by a “substantial amount” there are hopes that the Committee will vote to leave rates unchanged.

Following last month’s surprising pause in the recent falls in consumer prices, Bailey is confident that his forecast of a headline rate of inflation of 4.9% by the end of the year will be reached. He sees no reason for one month’s data to divert the Bank from its plans to continue to be data driven.

With average earnings also falling last week, there is further hope that the Bank will see a path to holding the base rate at its current level of 5.25%. Food inflation however remains high at 12.5% with food prices in the UK and Europe remaining stubbornly high.

The interest rate increases that have continued for close to two years are now having a definite effect on demand. Data for money supply shows that it is at its lowest for ten years as interest rate increases have dampened borrowing demand.

The September employment report is due for release tomorrow, it is expected to show that the number of claimants fell which may also influence the MPC to leave rates on hold. The unemployment rate is expected to remain unchanged at 4.3%.

The pound managed to pull away from its recent lows against the dollar reaching a high of 1.2170 and closing at 1.2164. However, against the Euro, Sterling continues to lose ground.

It fell to a low of 1.1440 last week, although it recovered to close at 1.1482, close to its lowest level since May.

The outcome of next week’s meeting of the FOMC is likely to be a close call. As interest rates come close to restricting demand it will become harder and harder for Jerome Powell and his colleagues to justify further rate increases.

Fed Chairman Powell spoke last week of his surprise at the resilience of the economy. In an interview with the Economic Club of New York, Powell said that during his second term that has included the Pandemic, a government shutdown and inflation that raise higher and faster than the Fed and many others expected that he could have “done things a little differently, but hindsight is a wonderful thing”.

He felt that less aggressive monetary stimulus during the Pandemic would have seen inflation still rise, but maybe it would have been easier to control subsequently.

However, Powell believes that he can be satisfied with the results of the FOMC’s actions, at least for now.

In a stance that has become something of a trademark, Powell refused to play down the possibility of further interest rate increases, although he acknowledged that the FOMC can now afford to be data dependent.

The latest employment report shows the resilience of the economy, and until it has moderated, rates will likely need to rise further.

Last week, economic and financial news was overshadowed by the diplomatic efforts to avert a humanitarian crisis in Gaza with President Biden visiting the region, and his Secretary of State, Anthony Blinken engaging in a round of shuttle diplomacy.

The oil price has begun to rise due to the conflict but with Saudi Arabia having increased production, it is not expected to rise much further. The effect on inflation in the developed world has already been seen.

Last week the dollar stayed in a narrow range as events in the Middle East took precedence. The dollar index fell marginally to a low of 105.95 and closed at 106.15.

This week will see the publication of output data for manufacturing and services. While manufacturing output hovers just below the line which indicates expansion or contraction, services are expected to remain just in expansive territory.

Despite the Eurozone existing for almost twenty-five years many nations are still acting independently when it comes to fiscal policy. There is a definite view that to blunt some of the most recent monetary policy decisions of the ECB, fiscal policy can be substantially looser.

One example of this is the latest budget revealed by Italy which looks uncomfortably like the disastrous budget, subsequently reversed, of Liz Truss a year ago.

Giorgia Meloni, the far-right Prime Minister of Italy is clearly making a point to the ECB that while the growth and stability pact remains suspended, she will promote growth to the detriment of the “bigger picture”.

She has fomented a storm in the bond market as spears on Italian ten-year bonds have “blown out” to 207 basis points, as borrowing costs topped 5% for the first time since 2012.

Economists are fearful of the effect of any further external shocks on the Italian economy.

On the plus side, the Greek success story continues with Greek Government debt returning to investment grade for the first time in a decade.

The Eurozone has clearly developed a two-tier economy since the era of low interest rates has ended. The hawks retain control of the Governing Council, but their command is beginning to waver as even the ECB President feels that interest rates are now at a restrictive point.

There have been several false dawns as the ECB has met to decide on the future path of interest rates and this week’s meeting is no different.

There is still a faint hope being expressed that a pause may be announced but given the recent comments that there will be no pause, only an end to the cycle, this month may be too soon given the most recent inflation data.

The ECB will also release its lending survey this week. It is expected to show that activity continues to slow. This will be backed up by output figures which show that the overall economy continues to shrink.

The Euro is showing some resilience. Apart from its show of strength against sterling, it rose to a high of 1.0616 last week, although it fell back to close at 1.0593.

Have a great day!