2 March 2023: No decision yet on rates, says Bailey


  • House prices fall by most in more than a decade
  • Manufacturing sector contracts again
  • Moody’s upgrades outlook for Eurozone
GBP – Market Commentary

No easy path to lower inflation

Andrew Bailey, the Governor of the Bank of England spoke yesterday of the possible need for the Bank to continue to raise interest rates although nothing is decided in advance of the next Monetary Policy Committee meeting.

While he is relieved to see the cost of living crisis begin to ease, there is still work to be done to ensure that inflation does not become ingrained in the economy as it has in the past.

There has been a significant improvement in economic activity since the turn of the year but the rise in wages is a concern although he can understand that workers, especially in the public sector, want to see their salaries keep up with the cost of living. Making demands for inflation busting increases will create a wages/prices spiral which will not benefit anyone.

There is no easy way to bring down inflation and the bank of England is cooperating with the treasury to ease the burden of sky high inflation. The Bank Of England will continue to raise interest rates as long as it deems it necessary to do so, although it is forecast that it will fall naturally this year as the global economy develops.

Bailey was at pains to suggest that nothing is cast in stone and the Central Bank is driven by the incoming data although it is in no one’s interests to make policy decisions based upon a single month’s data but rather studying the trend.

Although short term interest rates have moved from 0.1% in December 2021 to 4% following the latest hike of 0.25% no amount of tightening can immediately ease the unprecedented rise in food prices or deal with the energy shock that has taken place over the last year.

Realistically, the country is only just fully recovered from the Pandemic and the level of fiscal support that was deemed necessary to ensure that the economy didn’t succumb to the dangers of collapsing productivity and output.

The Bank of England still has to achieve a balancing act in which the desire to bring inflation back to its target level is done with consideration to the need for the economy to continue to show positive levels of growth.

Bailey welcomed the fall in energy prices but understands that they are still a challenge to many households, particularly those on low incomes.

One area in which the rise in interest rates is having an effect is the housing market. Data released yesterday showed that house prices fell in February by 1.1% following a 1.1% rise in January.

Sterling remained in its recent range this week as investors mull over, not the prospect of continued moderate rate increases, but more likely when they can expect a sea-change in the Bank’s policy, which according to Bailey won’t happen possibly until the summer.

The pound closed the day virtually unchanged at 1.2018 having opened at 1.2027.

USD – Market Commentary

Unlikely to catch up with inflation any time soon

Following last month’s almost unbelievable rise in job creation, which perfectly illustrated the futility of trying to predict the employment data, analysts and commentators continue to figuratively play pin the tail on the donkey, with no solid basis on which to anchor their predictions.

The fact that the FOMC has in all probability caught out by not having the latest data to hand when it decided to lower the rate of increase in short-term interest rates from fifty basis points to twenty five, while a couple of days later it saw a rise in jobs created more akin to an economic boom that one apparently teetering on the brink of recession.

Of course, trying to predict next week’s release of the February employment report is more scientific than a party game, but anyone who is able to accurately predict how many new jobs have been created in the latest month are either extremely lucky or have some kind of access to the data.

The economic recovery following the Pandemic has been extremely patchy. Just as data shows that the recovery is strengthening, a new set of data is released which points towards a continued slowdown and vice versa.

One area that remains a concern is the fall off in the level of diesel consumption. This shows that transportation is not using as much as it was, which leads to the inevitable conclusion that manufacturing and freight activity. In fact the latest figures show that consumption of diesel and other distillates was its lowest in a decade.

Nearly 80% of consumption is used in haulage, manufacturing and construction which points to a significant correlation.

In a threat to the independence of the Central Bank, Republican members of Congress are beginning to make noises about the continued rise in interest rates that they consider to be a threat to any sustained recovery.

They do not consider it sufficient for the Chairman of the Federal Reserve to appear before them on a six monthly basis to explain why the FOMC acted as it did. There are calls for greater oversight, and possibly some participation in the process.

A more likely future path is for the number of representatives from regional Federal Reserves to be increased with a reduction in the number of permanent members who base their votes on personal theory rather than actual activity.

The dollar index has been continuing to see some strength as the market feels that, on balance, the Fed will continue to raise interest crates for at least two more meetings.

It rose to a high of 105.09 yesterday, but fell back to close a little lower on the day at 104.39.

EUR – Market Commentary

Rates will rise for as long as necessary according to Nagel

Bundesbank President Joachim Nagel took a page out of Christine Lagarde’s inflation fighting playbook in a speech yesterday. He agreed with Lagarde’s recent comments that not only will the ECB raise rates at its March meeting, but it will continue to tighten monetary policy until inflation is back close to the Central bank’s target of 2%.

Inflation data for Germany was published yesterday. It showed that in February, it rose by 0.1% from 9.2% to 9.3%. With the composite figures for the entire eurozone due for release later this morning, the fact that several of the individual components that make up the figure have risen, inflation is expected to have risen as well.

The statisticians use a harmonized method to ensure that a country’s data is looked at in a similar manner, but this takes no account of seasonality. For example several products that make up the ECB’s basket are seasonally affected. In winter, the needs of consumers in the Baltic States are vastly different from those in Southern Europe.

Inflation is currently significantly higher in Latvia, Estonia and Lithuania, than it is in Spain, Portugal or Italy.

Nagel went on to say in his speech that stubbornly high inflation will require the ECB to raise interest rates well beyond its next meeting and will also need to consider a significant reduction in the size of its own bond portfolio. This is further bad news for the severely indebted nations like Italy.

They face not only the prospect for higher short term rates but a restriction on their ability to tap international bond markets to fund their expensive and continuing social welfare programmes.

In a follow up to her call for individual nations to pare back energy support payments, Christine Lagarde warned yesterday that if there is a continued lack of fiscal cooperation, the ECB will be forced to compensate by raising rates for longer.

Over the period when G7 Central Banks have continued to raise interest rates, the Eurozone has stood out as the only area where the Central Bank is expected to carry the burden alone.

The eurorose to a high of 1.0691 following the inflation data and closed at 1.0665. There is some minor resistance around the 1.0710/20 area and if the single currency can break through that it may test more significant resistance at 1.0800.

Have a great day!

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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.