- Rate hikes have taken a toll on growth
- Job numbers remain healthy
- The Eurozone’s growth engine will continue to splutter
Will the Bank of England enjoy the luxury of patience?
The first few weeks of the New Year will see the market remaining in “2023 mode” as a new set of drivers are yet to begin to take effect.
The first half of the year is expected to be characterised by speculation about when Rishi Sunak will call a General Election and when the Bank of England will decide to cut interest rates.
No Central Bank likes to be forced by events to change monetary policy, much preferring to be in control, or at least portray the illusion that it is in control.
For that to happen this year, the MPC must appear to be far more proactive and show the market that it is on top of the decline in output.
With three members of the MPC, Jonathan Haskell, Megan Greene, and Catherine Mann, still voting at the latest meeting for rate hikes to continue, it gives the impression that the Committee is “behind the curve.”
Inflation has finally begun to wane, with the headline rate expected to have fallen again when the December data is published on 17th January. It is expected to be close to 3%, given that the forecourt price of petrol has continued to fall.
The quarterly figures for GDP will not be available until early February, but with October seeing a 0.3% fall, and November expected to be similar, there is little hope that the country avoids falling into a recession in the final quarter of 2023.
The final Budget of this Parliament will be presented to the House of Commons on 6th March. The Chancellor is expected to announce a series of tax cuts, which in concert with the first-rate cuts may lift the country’s mood.
So far, the MPC has been unwavering in its belief that interest rates need to remain elevated to see inflation “defeated,” but, just as it claimed that rising inflation was at least partly due to “circumstances,” so the fall in the rate of price increases has been partially due to global events.
It has become clear over the past six months that the independent members of the MPC may be considered “window dressing” by the market, while the Governor and his colleagues from the Bank of England hold sway.
Until there is a “sea change” in their view of inflation, the country will not see the rate cuts that its economy is demanding, although the pound will remain supported.
Last week, Sterling rallied to a high of 1.2828 and closed at 1.2748 as the market was driven by end-of-month commercial demand. This week, as normal liquidity resumes there is no significant data due that will drive the pound, so it is likely to remain reactive to events in the U.S. which will see the December employment report delivered.
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Jobs and Inflation set to Prove Fed Chair right.
While Jerome Powell is the first to admit that he did not get every call right as the Fed battled against rising inflation, he certainly did enough for the market to “cut him some slack.”
It is obvious from the way that he is continually criticized for his comment in November 2022 that the rise in inflation was “transitory” and due to the “extraordinary” levels of fiscal support that were provided during the Pandemic, and would soon be absorbed, shows that his most heinous “crime” has been to be a lifelong Republican at a time when Congress has a Democrat majority.
Powell has brought a “lawyer’s eye” to his Chairmanship, which has afforded him a more rounded view of events than his predecessors. He has allowed more latitude to his colleagues on the FOMC, encouraging them to show that their discussions at the six-weekly meetings are both lively and constructive.
While in the past, the Central Bank has been seen as “Greenspan’s Fed” or “Bernanke’s Fed,” there is a much more rounded discussion under Powell with regional variances considered.
A year that started out with fears over a recession as interest rates continued to rise ended with a remarkable show of resilience where an average of 230k jobs per month were added, although this figure was in the main due to significant gains made over the first half of 2023 before rate hikes began to bite.
The unemployment rate remained below 4% during the whole of the year, which is remarkable given that in the recent past, anything below 5% was close to full employment.
This week’s data will be as unpredictable as ever. Early forecasts are for around 160K new jobs to have been added, with the unemployment rate ticking up from 3.7% to 3.8%.
The dollar index had a turbulent December. In the last week of the year, it fell briefly to a low of 100.61, but quickly recovered to close on Friday at 101.33.
While it cannot be said yet that conditions are set fair for the dollar, longer term forecasts for G7 economies show that the U.S. should fare better than either the UK or Eurozone.
Rate cuts expected to begin in Q2
It is tough for several Eurozone members who have seen significant rate increases blunt their efforts to reflate their economies using fiscal measures that remain available to them, to now see rates expected to remain at a severely restrictive level for the foreseeable future.
The ECB is unlikely to be concerned by a recession, which it believes will be the lesser of two evils when compared to the fear of rampant inflation.
Christine Lagarde and her colleagues will continue to be hawkish over the rate of price increases until inflation has fallen below its 2% target.
Around eighteen months ago, there was a furore as Lagarde announced a change in the target from 2% to an average of 2%.
This meant that since inflation had been significantly below 2% for some time before the announcement was made, the ECB may allow inflation to exceed 2% before it felt to need to be concerned or to take any action. It was felt at the time by the more hawkish members of the Bank’s Governing Council that the relinquishing of control would allow inflation to rise, which it subsequently did.
They immediately exerted a degree of control that bordered on the Draconian but still made the fatal error of lowering the incremental size of individual rate increases.
This has meant that rates had to be hiked at one, and possibly two meetings more than was strictly necessary, leading, inevitably, to recession.
Germany, which for years has been the economic engine of the Eurozone, has suffered more than most of its neighbours from the downturn in economic activity and has already been in recession longer than other nations in the region.
There was some attempt made, at the height of the energy crisis, which threatened to engulf the Eurozone at the end of last year, to inflate the economy, but that has been singularly unsuccessful.
Now, with loosening monetary policy the only option left, the market will actively test the resolve of the ECB, constantly reminding it of the inevitability of rate cuts.
The Euro had a surprisingly strong December, although it appeared to run out of steam towards the end of the month. It rallied to a high of 1.1139 and closed at 1.1041.
It is unlikely that the common currency will be able to garner continued support at these enhanced levels, and it should see some strong selling pressure as the market returns to full capacity.
Have a great day!
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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.