29 June 2023: The Bank of England needed strong response to May inflation report

Speaking at an event hosted by the ECB yesterday, Andrew Bailey continued the hawkish rhetoric he used when announcing the fifty-basis point increase in interest rates last week.

He told the assembled journalists that having studied the surprisingly bad May inflation report that a strong message needed to be sent to the market.

There was discussion about hiking by fifty basis points over two meetings, but, on balance, the MPC felt that a single rise would hold a more effective message.

The effect of the employment and inflation reports made it clear that if the Bank was to be considered serious about the need to bring inflation under control, a strong message needed to be delivered.

The Treasury is believed to be concerned about the comments attributed to Bailey recently in which he was sanguine about rate hikes raising unemployment as demand in the economy.

Making the most marginalized sector of the economy unemployed to control the cost of living to be considered normal is an extremely dangerous game.

For the Government to condone such actions paints it in an extremely poor light and weakens even further the chances of the Conservatives being re-elected at the next General Election.

The MPC represents a very narrow view of economics with the Governor a lifelong employee of the Bank, while several of his colleagues have been drawn from various banks in the City of London. The degree of “groupthink” that they represent means that there is little opportunity for other ideas in the relationship between wages and inflation compared to interest rates and inflation.

Overall, the right-wing ideals taught at the London School of Economics, which a majority of the committee attended, are responsible for monetary policy.

There are moves being discussed within the Treasury for a more representative blend of views to be taken, which would look more at the “bigger picture.”

Also speaking this week, MPC member Silvana Tenreyro, who will leave the MPC following the September meeting, outlined her fears that interest rates will “overshoot” and eventually push inflation below the Government’s 2% target as the economy “catches up” with monetary policy.

She intimated that the MPC had been unable to hold its nerve when considering the May inflation report and had acted precipitously in hiking by fifty basis points.

The pound fell to its lowest point in two weeks yesterday as the market became concerned about how high the base rate will need to rise to bring inflation under control and its effect on growth.

It reached a low of 1.2606, closing at 1.2635.

Jerome Powell removed the last vestiges of doubt that the pause in the Fed’s cycle of interest rate hikes announced at the last meeting of the MPC was anything by just that.

In a speech yesterday, Powell was more upbeat about the resilience of the economy, commenting that the data that he had seen recently led him to believe that a minimum of two further rate hikes would be easily absorbed.

He acknowledged that a recession is possible given the sometimes-surprising nature of the economy, but he downplayed the threat.

While growth will be “modest” this year, the actions that have been taken by the administration, as well as the Central Bank, are laying the foundations for a strong recovery going forward.

Inflation has fallen significantly since last summer when it came close to getting out of control and warranted the decisive action that the FOMC took, but now the actions need to be more considered since rates are on the cusp of becoming restrictive.

The June employment report that will be published next week will show that in the first half of this year a considerable number of new jobs were created, far more than anyone had imagined.

The headline non-farm payroll data has exceeded estimates every month since January, but there are signs in the data that the rate of job growth is slowing.

The weekly jobless claims data has been gradually growing over the past couple of months and is now averaging well over 250k new claims per week.

The final estimate for Q1 GDP will be published later today. It is expected to confirm that the economy grew at a sluggish rate of 1.3% year-on-year from January to March.

The dollar index climbed and reclaimed the ground that it had lost this week, mostly in reaction to market concerns over other economies.

It reached a high of 103.14 and closed at 102.99.

Italian Prime Minister Georgia Meloni lashed out at the ECB yesterday, calling its approach to monetary policy “simplistic” and saying that the considerable rises in interest rates that have already taken place to try to control inflation are materially damaging individual economies of the Eurozone.

She told the Italian Parliament that the high rate of inflation that is being seen in the region currently is not due to overheating, but a consequence of the energy shock, and the war in Ukraine.

Those on a fixed income, an issue that affects Italians more than most other eurozone nations, are paying a “hateful” and unnecessary tax due to continued price rises that are a direct consequence of the ECB’s rate hikes.

In contrast to Meloni’s comments, ECB President Christine Lagarde told the Central Bank’s annual conference in Sentra, Portugal, that interest rates, already at their highest for twenty-two years, needed to be raised further to counter the soaring wage settlements that are being seen throughout the region currently.

The lack of a fiscal union is contributing to this issue since the Union has no way of controlling public sector pay in its twenty member states.

The issue of high-interest rates is a particular issue in Italy not just because there are so many people on state benefits, but also because it has the highest debt-to-GDP ratio in the Eurozone. Which at the last estimate was at 144%.

Meloni’s words were backed by Foreign Minister, Antonio Tajani and Deputy Prime Minister, Matteo Salvini, who has a reputation as something of a “firebrand.”

Meloni went on to say that rather than raising interest rates, the ECB would be better served by introducing measures to control the price of raw materials and energy, which are the source of inflation.

The euro again shied away from the 1.10 level yesterday, it fell to a low of 1.0896 and closed at 1.0913.

Have a great day!