- MPC increasingly concerned about effect of hikes on economy
- Fed hikes and vows to continue
- Inflation falls for third straight month
House prices fall by 0.6% in January
Longer term, buying a house or a car are no longer considered within reach, and this disenchantment is manifesting itself in industrial action as real wages continue to fall.
While not every reason for the current cost of living crisis can be laid at its door, the current government must shoulder a large part of the blame for first allowing the situation to become so grave and then failing to act other than to put in place temporary measures to help in the short term.
The NHS and virtually every other part of the public sector from teachers to border control staff to driving test examiners and civil servants, took industrial action yesterday, and the message to Rishi Sunak and his Cabinet is becoming clearer by the day, if the present government continues to deny them a living wage then they will elect a more sympathetic Party.
While the government continues to stand firm, the edifice of public services is crumbling around them. Productivity is falling rapidly, as workers believe that if they are being paid breadline wages, they will do the bare minimum.
It is no surprise to learn that the IMF believes that the UK will have the worst performing economy in the developed world this year. Workers having no confidence in their employers and having to fight tooth and nail to receive a fair wage increase which, if nothing else keeps up with the cost of living, that allows them to stand still and not go backwards is the minimum they can expect.
No one blames the government totally for the rise in inflation, but their reaction to it has been extremely poor, and asking the lowest paid to shoulder the burden of bringing the cost of living down is draining away any support they achieved in the 2019 election.
They have squandered the opportunity they were given, and it will be a Herculean task to even put up a reasonable showing in early 2025.
The Bank of England will add further to the gloom by raising short term interest rates today. A twenty-five point hike is likely as rates are now moving through the neutral phase and beginning to restrict the economy. This will contribute to the depth of the recession that has likely already started.
The pound rallied to a high of 1.2395 in reaction to the outcome of the FOMC meeting and was able to cling on to its gains, closing at 1.2374.
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Powell sees inflation as too high
The dollar index fell to a low of 101.03 in reaction to what the market considered to be a more dovish statement than has been seen following recent meetings.
Several members of the committee had said in advance that they favoured a twenty-five point hike, and that was the general feeling in the market.
With the economy faltering, Jerome Powell allowed him to be persuaded that inflation is beginning to fall and now with rates definitely in restrictive territory, the fall should accelerate.
Inflation remains well above the Fed’s long term goal of two percent, and vigilance is necessary to ensure that core inflation continues to fall.
At his press conference, Powell commented that although inflation has moderated recently, the fight goes on, although the need for aggressive action has now passed.
Powell went on to say that the past three months have been encouraging, more evidence will be needed to encourage the Central Bank that inflation is on a sustained downward path.
The dollar’s reaction was fairly predictable. Although, the Federal Reserve wasn’t the first G7 Central Bank to begin to tighten monetary policy. Its aggressive stance, including a series of jumbo hikes of seventy-five basis points, means it will most likely be the first to pause.
That will probably happen at the end of the current quarter, although the FOMC will remain vigilant.
The gradual slowdown in the economy is continuing. House price increases moderated to 6.8% in January, falling from 8.7% in December. Manufacturing output, already contracting, eased a little further to 47.4 from 48.4.
There was little indication from the Fed Chairman that he had advance knowledge of the January employment report, so the market has little to go on to support the view that new jobs created will see a substantial fall.
Having fallen through support at 101.60 the dollar closed at 101.14 and the market will see how hawkish the comments that follow the ECB meeting later this morning are before continuing selling the Greenback.
Fifty basis points still expected despite falling prices
Christine Lagarde will be hard-pressed to deny that the trend for inflation is lower when she speaks following today’s meeting of the Governing Council of the European Central Bank.
While the hawks will still push for a seventy-five point hike to accelerate the pace of the fall in inflation, justification will be difficult to find, and twenty-five points will now look an attractive option.
However, the compromise of fifty points will probably be agreed, with the justification coming in the shape of continued concerns that inflation still isn’t falling at a fast enough rate.
A hawkish ECB appears to lack the subtlety to use monetary policy with a degree of discretion, and that is mostly due to the unwieldy nature of a twenty-man committee which has very little room to manoeuvre outside what is considered to be normal policy decisions, and it is also lacking the support of a finance ministry or a treasury to help with blanket fiscal policy.
The press conference following the meeting will be just as important as the rate announcement, unless there is a major surprise. The justification for the hike and some advance guidance concerning the next one of two meetings could see the single currency make further gains after its strong performance in the wake of the FOMC meeting.
Overall, most data being released for the entire region is adding to the confidence of the population, although there is still concern regarding the war in Ukraine, which has seen something of a lull during the harsh winter. With both sides expected to launch spring offensives, the danger of a significant escalation remains.
The euro rose to a high of 1.1001,closing at 1.0980 breaking through long held resistance at 1.0920, and the ease with which this was achieved bodes well for further gains.
Have a great day!
Exchange rate movements:
01 Feb - 02 Feb 2023
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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.