24 July 2023: Bank expected to be wary of the recession threat

24 July 2023: Bank expected to be wary of the recession threat


  • A recession remains a real danger
  • Major banks are upgrading economic forecasts
  • Core inflation is still a reason for further hikes
GBP – Market Commentary

The Central Bank may revert to dovish hikes at its next meeting

Last month’s fifty-point hike in the base rate of interest is being considered a “rush of blood to the head” that came because of the headline rate of inflation in May remaining unchanged.

Using the same logic, the market expects the MPC to revert to its staid policy of twenty-five-point hikes that have become its “staple offering” for almost the entire period of its current rate hike cycle.

The meeting, which takes place next Thursday will be the first since Silvana Tenreyro completed her stint as a member, and it is unlikely that her “ultra-hawkish” views on inflation will be continued by her replacement, Megan Greene.

Greene who will bring a wealth of international economic experience to the role will take time to bed into the role just as her predecessors have.

With Michael Saunders having left almost a year ago and Tenreyro having just left, the MPC has been shorn of two economists who believed that rates would have risen faster in response to the factors that were driving inflation.

That having been said, until the make-up of the committee is radically changed, it will continue to suffer from groupthink. Alternatively, one member of the committee who is a Bank of England staff member will have to break ranks and “vote his conscience.”

Mortgagees are facing more concerns about their home loans as the Bank of England comes close to the end of its twenty-month cycle of interest rate hikes. Although rates are likely to remain high for a period of at least six-month, a lot will then depend on the state of the economy in the run-up to the General Election.

It is unclear whether the “fashion” for fixed rate mortgages will be so attractive to borrowers as rates begin to fall whether there is a recession or not.

Although the results of last week’s by-elections were predictable, Sir Keir Starmer has written to the Mayor of London to discuss the enlargement of the Ultra-low emissions zone which, Starmer feels was behind the Conservative’s victory in Boris Johnson’s old constituency.

Sadiq Khan has been criticized by some Labour Councillors for increasing the burden on Londoners when they are already struggling with the cost-of-living crisis on what has been called a “vanity project”.

In other parts of the country, the by-election results confirmed the probability that the eighty-plus seat majority that the conservatives won in 2019 has been squandered, most through the antics of former Prime Minister, Johnson.

The results indicated the rise of the Liberal Democrats following a devastating showing at the last election.

This also brings concerns for Labour as neither they, nor the Lib-Dems, will want a coalition should Labour fail to gain an overall majority.

Last week, Sterling nose-dived following the release of inflation data for May. As inflation fell, so did the chances of a further fifty-point rate hike.

It fell, versus the dollar, to a low of 1.2816, closing at 1.2853, as it handed back the gains made in the previous week.

USD – Market Commentary

Rate surprise is unlikely

Another FOMC meeting, another potentially “pivotal week” for interest rates. Although there remain “rumblings” over the threat of a recession, the FOMC will hike rates by twenty-five basis points this week.

Jerome Powell will try to persuade his colleagues that although headline inflation fell to 3% in June, there are still secondary effects that are keeping core inflation higher than he would like.

Last week constituted the “black out” period in which FOMC members are prohibited from discussing the economy or their voting intentions.

There is an odd phenomenon taking place in the economy currently. Although most front-line data is showing that the country is gradually beginning to post respectable numbers again, there are several longer-term items that still point to a recession. The inversion of the yield curve is the standout factor as well as is a long-term view of productivity.

These two will need to be flaunted if the economy is to avoid a recession in the next eighteen to twenty-four months.

The market’s expectation is that the FOMC will hike this week then consider not just a pause, but the end of its cycle of rate hikes.

The dollar index has been exceptionally volatile over the past couple of weeks as the weakness of the Eurozone and UK economies was overtaken by the prospect of a widening gap between euro and GBP interest rates on one side and dollar rates on the other.

This makes the “carry” on long dollar positions ever more expensive. As questions over a continuation of the ECB’s rate hike policy into the Autumn rage on, the dollar index regained both its composure and the 100-level last week.

It climbed to a high of 101.74 and closed at 101.09. A lot will depend on Jerome Powell’s choice of words at the press conference following the rate decision on Wednesday evening. Traders and investors will be looking out for certain words and phrases which betray the intentions of the committee going forward.

Next week will also see the release of the July Employment report where a continuation of the gradual cooling of the jobs market is expected to continue.

EUR – Market Commentary

The ECB is increasing its monitoring of bank liquidity

The ECB is struggling to maintain its hawkish persona ahead of this week’s meeting of its Governing Council.

There has been a “plethora” of comments from members of the committee almost since the previous meeting ended, about how the hike that will take place this week, may easily be the last.

The headline rate of inflation has been falling steadily over recent months, but it is the core rate that remains stubbornly high.

Christine Lagarde, the President of the Central Bank, believes that core inflation is not falling in conjunction with the headline rate due to profiteering from suppliers and retailers who have struggled to maintain their margins due to lower retail sales and supply difficulties.

As not just the custodian of monetary policy, but also the market’s chief regulator, the ECB has been looking more closely at bank liquidity recently. There has been no official acknowledgment of the change in policy, or a reason given for greater surveillance; market analysts believe that the Central Bank remains concerned about banks’ exposure to bad or non-performing loans.

Over the period immediately following the financial crisis, the ECB “bent over backwards” to allow banks time to repair their balance sheets by bending or occasionally changing accounting rules to allow banks time to write off or write down bad or doubtful loans.

It was felt that during the undoubted period of stability and expansion that would follow the crisis, banks would be able to repair their balance sheets.

Unfortunately, the Eurozone lurched into the Pandemic which was followed by the current cost of living crisis, which has afforded weak banks little or no time to repair the damage.

The countries that are continuing to push for higher rates are mostly those who do not have a potential problem, although there is one exception, Germany where the ECB is being particularly vigilant given the country’s previously close relationship with Russia.

Last week, the relationship between the euro and higher interest rates, which had been so supportive recently appeared to evaporate. The single currency fell to a low of 1.1107 and closed at 1.1126.

The ECB meeting will be the highlight of the week, although members of the Governing Council will go off on their annual holidays with the thought of having to make a far tougher decision than they made this week constantly invading their minds.

Have a great day!

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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.