28 July 2021: Vlieghe a hawk in doves clothing

Vlieghe a hawk in doves clothing

28th July: Highlights

  • UK 2021 growth to equal U.S.
  • IMF Upgrades U.S. growth projection
  • Lagarde’s patience to upset German inflation concerns

MPC member sides with doves as rate hopes dashed

Any thoughts that the Bank of England may be considering tightening monetary policy were dashed when usually hawkish Gertjan Vlieghe commented that he does not believe that now is not the time to tighten monetary policy.

The level of uncertainty, that could still derail the recovery, means that the Bank is unlikely to tighten monetary policy this year.

Despite there being almost zero chance of a rise in interest rates or any change to the Asset Purchase Scheme, next week’s meeting will still attract the market’s attention since there is a possibility that Andrew Bailey will provide further guidance as to the Bank’s intentions.

The IMF published updated guidance following a review of potential global growth forecasts yesterday. The UK is set to rival the U.S. by growing by 7% this year.

However, that will still leave the UK economy smaller than at the start of the Pandemic, having shrunk by 9.8% in 2020. In contrast, the U.S. which is also expected to grow by 7% this year saw a fall of 3.5% and will therefore start 2022 well ahead of its pre-Pandemic level.

The country still faces economic headwinds as it recovers from the Pandemic. Although infections are beginning to fall again, the reason for this is still unclear and therefore doubted by certain sections of the population.

Outside of Covid-19, Brexit is set to blow up again, as London and Brussels remain locked in a dispute regarding goods passing through Northern Ireland.

While the UK has very little to argue about having signed the agreement, it is common sense that there would be an element of testing the water over certain sections. Ireland was always going to be contentious since it is the only place with a land border.

It was obvious to trade experts at the time that Boris Johnson was so keen to get the deal done within the timeframe he had set, that he knew that a certain amount of renegotiation would be necessary.

Brussels was clearly either not aware that this was possible, or more likely chose to ignore a flaw that was fairly obvious.

The financial markets continue to position themselves ahead of the announcement from Jerome Powell later on today regarding FOMC monetary policy guidance.

The pound recovered a little more ground yesterday. It rose to a high of 1.3894 and now faces fairly tough resistance at around 1.3900 if it is to try again to break the 1.40 level. It eventually closed at 1.3879.

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Tighter policy will wait until FOMC certain of recovery

One of the less important facts made about the FOMC meeting, which concludes later today, and will be followed by a Statement delivered by Chairman Jerome Powell and a press conference, is that it has not been labelled by observers as one of the most important in recent years.

Successive meetings have been considered to be the most important since the financial crisis, but the market now appears to have accepted that the Fed is unlikely to provide such a seismic shock without a significant degree of advance guidance.

Therefore, the best that the market can expect is an honest appraisal of the progress that has been made since the last meeting, the pitfalls that have been seen and the likelihood that they will be repeated.

Powell will then move on to the future and deliver the committee’s view of how the economy is going to perform going forward.

It now seems that the most important question is will the Fed tighten this side of the end of the year.

It is highly unlikely that Powell would paint himself into a corner, so any possibility of his doing any more than inferring when the tightening will happen is remote.

If it is simply a choice of whether to try to contain inflation which is close to out of control, then the market would be certain.

News from Congress yesterday confirmed that President Biden’s infrastructure plans are likely to be approved by the weekend. This will add to inflation going forward.

Overall, expectation is for Powell to subtly amend the words of his statement to allow the markets to digest when a change in policy will finally arrive.

The correction of the dollar’s recent rally that was backed by a view that the Fed would act sooner rather than later has now dissipated and the waiting game continues.

Yesterday, the dollar index fell to a low of 92.31, cloning at 92.48. Any thought of a challenge to resistance at 93.20 now looks some way in the future.

Von der Leyen, caught between her job and her country

Conversations between the ECB President and the President of the European Commission are likely to be tense affairs in the coming weeks.

The Central Bank is in something of a difficult position. While Christine Lagarde is often at pains to reinforce its independence, which is a vital part of its fabric, right now the controversial decision to change how inflation is treated requires wider support.

Ursula von der Leyen is in a difficult position. As part of a German Government that believed that control of inflation was its number one priority, she would naturally lean towards tighter monetary policy.

However, as EU Commission President, she needs to be more sympathetic towards the areas of the Union that would suffer should policy be tightened, and support withdrawn prematurely.

Lagarde has a new byword, patience. She believes that it is vital for the RCB not to repeat mistakes of old, when rates were raised too soon following the end of a recession and nascent growth was choked off.

This time around, it seems that the doves are in the ascendancy, and while Lagarde cannot number herself among them, her impartiality will be causing angst in Frankfurt.

There continues to be a certain degree of ambiguity about data releases, both in Germany and across the wider community.

It appears that while the consumer is fairly confident of the recovery, possibly driven by the availability of both doses of the vaccination, industry and manufacturing continue to struggle.

One of von der Leyen’s priorities will be to promote intra-union trade. While exports will gradually pick up as the recovery continues, they are being outstripped by imports as many countries prefer to import cheaper products while the quality of locally produced items is of secondary importance.

The euro is also afflicted by the outcome of the FOMC meeting. Yesterday, it rose as the dollar index fell. It reached a high of 1.1841 but fell back to close at 1.1817 which was the high from the day before.

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.”