Even Bailey is facing staff pay mutiny
29th June: Highlights
- Bleak outlook pushes Sterling lower
- Consumers concerned about inflation not recession
- Lagarde expects above trend inflation for the foreseeable future
GBP – Bank trying to show restraint in face of inflation
Having emerged from the Pandemic, no one in authority had any idea just how seismic the effect on supply chains would be.
It was obvious that during the Pandemic there would be severe difficulties, but there has been a perfect storm of events that have left the UK weak and open to a downturn that could see a bona fide recession that will see the Central Bank’s hands tied as inflation continues to rise.
No one, outside a few Government departments, will have been aware of the incredible reliance that has grown on the supply of several staples produced by Ukraine, while Russia has been slowly building a reliance on its energy supplies almost under the radar.
There have been concerns raised about how Russia has been playing the long game, building its influence across Europe. The build-up of troops along its border with Ukraine was dismissed as little more than a show of strength, until it advanced into its former satellite a little over four months ago.
The effect of Brexit on the labour market was one of the pillars of the remain side. The Prime Minister acknowledged that things would be tough for a period while the economy adjusted, but that was little more than a hopeful view rather than a deep understanding of the delicate balance that would be subject to any other shock.
The rise in the price of energy has been a further contributory factor. Having fallen almost to one pound per litre, it has doubled in price in an incredibly short period, but without the factors that saw it rise in the past.
China will be eyeing what is happening in the UK and mainland Europe with great interest. It has embarked on a major campaign to increase its influence in mineral rich countries to ensure supply to its burgeoning industrial base. Little is being said now about the origins and spread of Covid-19, and there are theories around its spread.
China went out and tried to outbid all comers in the energy markets to ensure that when it recovered from the Pandemic, its industrial base would be able to perform back at its peak in the shortest possible time. The resurgence of the virus just as its major customers were recovering has been a significant factor in supply side inflation that the G7 economies have very few tools available to tackle. The situation will only improve when the oil price falls and since demand is at its lowest point through the Northern Hemisphere summer, the Government can only watch as output falters and the economy falls into a recession that will be fed as summer turns to winter and energy needs increase.
Yesterday, these mounting issues took a toll on the pound. It fell to a low of 1.2180 and closed very close to that level.
USD – Powell appears to wash his hands of responsibility
China has been unable to produce sufficient goods, in particular consumer products, to quell rising demand in the U.S.
Supply chains are still creaking and are also suffering from a lack of investment during the Trump era, when the previous President was happy to have a frosty relationship with China.
Trump constantly threatened to take back the American reliance on goods manufactured by China and reintroduce it to America. He was able to almost convince people that this could be done at pace, whereas it is clear that this would take close to a generation to reverse.
The world, America in particular, is now in the grip of Chinese manufacturing capability and its policy of securing supply chains of raw materials through soft loans and development agreements with producers.
The argument about whether the FOMC policy in fighting inflation continues, but it seems that Jerome Powell is determined to provide an answer in the coming months as the Central Bank continues to hike rates at a rate that is alarming to many economists.
FOMC members continue to promise to continue to hike rates, as they see inflation as the most significant current threat to the economy in the long term.
San Francisco Fed President Mary Daly commented yesterday that left alone, inflation would eat into the core of the economy and be a major constraint to growth for years to come.
Her colleague from the New York Fed, John Williams, said that a hike of seventy-five basis points will be discussed at the July meeting, and he couldn’t rule out an agreement.
The dollar index climbed to the top of its recent range yesterday as the market reacted to an escalation of hostilities in Ukraine. It made a high of 104.61, closing at 104.51.
EUR – Other issues faded into the background
A twenty-five basis point hike may be considered to be too little too late in some capitals, but that is what Christine Lager is most likely to support. Having dug her heels in over extended support for weaker economies, it will be significant longer term to see if she is able to hold the hawks at bay.
With the economy slowing rapidly and the consumer on its knees, several members of the governing council will see a concerted effort to bring inflation under control as superfluous given the factors affecting both inflation and the economy about which no Central Bank could do anything.
The proximity of the war in Ukraine to the borders of the EU exacerbates its effect, threatening to draw neighbouring countries into the conflict.
With Turkey agreeing that it will accept Sweden and Finland into NATO, and the European Commission agreeing to look favourably at Ukraine’s application to join, the political map of Europe will change again, much to the chagrin of Russia’s President Putin.
Moscow has already made threats about the consequences of Helsinki and Stockholm becoming NATO members, worrying that Washington will want to take full advantage of Finland’s close to 1,000-mile border with Russia.
The euro is likely to suffer even as the ECB begins to hike interest rates, particularly if the hike is only twenty-five basis points. With the Fed considering a seventy-five-point hike next month and the Bank of England discussing going to fifty-point hikes going forward, the growing interest rate differential will be a significant incentive for the market to drive the euro towards parity.
Yesterday, the euro fell to a low of 1.0503, closing at 1.0519. While it remains above 1.05 there will not be any momentum for traders to take short positions, but were the 1.0450 level to be broken on a closing basis it would spell the beginning of fresh impetus.
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.”