Rate hikes won’t cure inflation woes
28th March: Highlights
- Bank of England relying on textbook inflation response
- Consumer confidence falling across the developed world
- Lagarde adds food supply shortages to Ukraine fears
Public receiving a double punishment
Economics 101 states that in times of rising inflation, monetary policy should be tightened by contracting money supply via increased interest rates.
But this textbook was written to deal with the only type of inflation that had never been seen.
In the current environment, inflation has been created only on one side of the economy, with wages not having risen by any significant degree.
The UK economy has been significantly stimulated, albeit artificially, by the country’s emergence from the Pandemic.
Wholesale gas prices have been rising for over a year as demand from China as it emerged from its own Pandemic and demand for gas as factories reopened meant they were prepared whatever it took to secure supplies.
What would have happened if The Bank of England had simply sat on its hands? How long would inflation have continued to rise?
The rise in fuel prices combined with the rise in National Insurance contributions only marginally mitigated by the relief provided by the Chancellor last week, together with the increase in the consumer price cap will hit consumers hard and the Bank of England’s actions over the rest of the year will hit homeowners hard.
Banks are already increasing interest rates for home loans, and the deals that they were providing at close to giveaway prices are now outdated.
There is little doubt that 2022 is going to be something of a write-off in terms of wealth creation and any increase in the standard of living. The Office for Budget Responsibility, the Government appointed watchdog, believes that the standard of living in the UK will fall to its lowest level in 55 years.
The Bank of England will release its Quarterly Bulletin this week, although this is not usually a market moving event. Investors will be interested to see the Bank’s estimates for growth and inflation for the rest of the year, and what it projects for the path of interest rates.
Also due for release this week, is the final cut of 2021 GDP. While this is a long past event, it will provide the Prime Minister with an opportunity to gloat about how well the country emerged from the worst of the Pandemic.
Last week, Sterling was trapped between support at 1.3040 and resistance at 1.3280. It tested both sides, but ended up closing at 1.3182, virtually unchanged on the week.
Fuel prices and scaring off shoppers
While the country is close to a net exporter of energy, forecourt fuel prices continue to reflect the global rises.
Last week, several FOMC members appeared to be coming around to a fifty-basis point hike in interest rates at the next monetary policy meeting, while some believe that a combination of a hike and shrinkage of the Bank’s balance sheet may be necessary.
Money markets are pricing in a further 200 BP of hikes this year. That would bring the Fed Funds rate to almost exactly where a number of FOMC members put the neutral rate, where interest rates are neither stimulating nor cooling the economy.
Given the way in which inflation has broken significantly higher, due in no small part to the logistics bottlenecks that have built during the Pandemic, it may be that as those pressures ease, that inflation may begin to fall naturally. Clearly, a lot will depend on the outcome of the conflict in Ukraine.
Christopher Waller, a member of the Fed’s Board of Governors, spoke last week about how inflation in both house prices and rentals are being understated.
Sales of homes are beginning to fall, with pending home sales falling for the second month in a row in February. They had been expected to grow by 1% but actually fell by 4.1%
The coming week will culminate in the release of the March employment report. Before that data will be released for house prices, job openings, private sector employment, Q4 GDP and jobless claims.
The data for jobless claims will be eagerly anticipated, having fallen to well below 200k last week. 187k new claims were made in the most recent week and it will be interesting to note if there was some anomaly or if a sub 200k read will now be the norm.
The dollar index is reactive to global risk appetite currently but is also gaining some support as the Fed is now considered to be in full on hawkish mode.
Last week, the dollar index rose for the six time in the past seven weeks. It reached a high of 98.96, closing at 96.80
Not hiking won’t slow inflation, but nor will hiking
The European Commission, headed by Ursula von der Leyen, is strident in its defence of the Union, but it may very well be that monetary union will have to be abandoned, leaving a trading bloc in its place.
The various issues that have affected the Eurozone over the past ten, or so years have been worsened rather than helped by the existence of monetary union.
When several nations were forced to undertake Draconian measures to save their economies, Germany was at the forefront of making demands.
The difference now is that Germany is one of the main sufferers, and the man on the street is seeing the value of his savings and pension eroded by raging inflation.
This is the worst of all outcomes for the German people and could lead to a degree of militancy not seen in the country since the fall of the Berlin Wall.
The German Economy Minister Robert Habeck spoke last week of his hope that his country will have halved its reliance on Russian oil imports by late summer.
He went on to essay that all coal imports will end by Autumn and gas imports will be down to 24% also by mid-Summer.
The report on the German economy from the influential IFO institute was released last week. It showed a significant fall across all areas. It is hardly surprising that expectations were the hardest hit. That part of the report showed a fall from 98.4 to 85.1 versus an expectation of 92.
In the coming week, data for Consumer Confidence, retail sales and employment in Germany will be released. Consumer Confidence and Manufacturing Output for the wider Eurozone will also be published.
Last week, the euro continued its recent struggle around the 1.10 level versus the dollar. It closed the week at 1.0982, having bottomed out at 1.0960.
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.”