Cost of living to rise in H1
30th December: Highlights
- Confidence up, footfall down
- Market approaching an unpredictable period
- Is there any such thing as Eurozone inflation?
Energy, tax, and mortgage rates set to rise
The cost of energy will remain a significant feature of higher household bills, coupled with higher taxes as announced by the Chancellor in his budget, while rising interest rates will see mortgage payments rise over the medium term as fixed rate options expire.
The cost of these factors will add up to an increase of around £1,200 in the average household’s outgoings. Given the hole in the country’s finances created by supporting workers and businesses during the various lockdowns, it is unlikely that there will be any reduction in the tax burden for some time.
The increase in the price of energy is a factor of global demand and, again, while the pace of rising prices may moderate there is unlikely to be a fall in the medium-term.
Finally, having committed to using monetary policy to begin to slow the rise in inflation, the Bank of England is expected to continue to increase interest rates. This will have a significant effect on mortgage payments, and there is a large section of society which have never known interest rates at what should be considered normal levels.
The Government is taking a more active role in considering whether additional restrictions are necessary given the number of new cases of Coronavirus that appear to be setting new records every day.
While the Omicron variant is mild in its effect, the sheer number of people isolating due to either being infected or in contact with someone who has been infected, means that the rate of absence from work in the NHS is reaching dangerous levels.
This in turn means that the Government may be forced into actions it does not wish to take. A lack of home testing kits and the length of time people have to isolate for is worsening the issue.
Economically, the first quarter of 2022 is likely to be dominated by the Omicron variant and the path of inflation, with the pound being reactive to consumer sentiment.
Yesterday, the pound rallied as the dollar index continued its recent mild correction. It hit a high of 1.3499 and closed within a few pips to that level.
Calls begin for Q1 rate hike
This is happening in the U.S. currently, as the Fed is being accused of not taking rising inflation seriously enough. Analysts also have a tool which isn’t available to analysts; that of insight.
While it’s easy to make a more appropriate call on the withdrawal of support looking back, it was far from certain that the economy was going to recover unaided from the Pandemic.
Fed Chairman Jerome Powell, while calling inflation transitory and a factor of logistical bottlenecks and supply shortages, made it clear that the Central bank had to change its outlook from proactivity to reactive since it was seeing inconsistencies especially in the employment data that meant it had several opposing factors to contend with.
It is entirely possible that the FOMC will vote to end support at the end of February to allow it to hike rates by the end of the first quarter. This will be a significant action and its effect on financial markets will be difficult to predict.
The end of financial support followed almost at once by an interest rate hike will create a significant shock as the brakes are applied to the economy.
The dollar is likely to benefit from not only the gap in official rates between it and most of the G7, but also the belief that that gap is going to grow throughout the rest of the year.
The dollar continues to be affected by year-end activity that is adding to its recent correction.
Yesterday, the index fell to a low of95.76, cloning at 95.90. Short term sentiment could see it reach 95.50, but the current correction is unlikely to see it fall any further.
Even in rising prices, one rate doesn’t fit all
A topical example of this is inflation. In Lithuania, inflation is currently running at around 9%, while in Greece it is not too far above the ECB’s target of 2%. The average for the Eurozone is between 4.2% and 4.5% depending on the calculation which, again, differs from country to country.
This example begs the question about how monetary policy can be used to solve an issue that has varying significance across the entire region.
During the era of low interest rates, inflation has barely been a factor, yet various nations have bumped up against debt to GDP rules and budget deficit limits since they have borrowed to return their economies to pre-financial crisis levels.
The unravelling of this financial tangle will last for a number of years after Coronavirus has been brought under control.
It is unclear just how the ECB will be able to end its purchases of Government debt, and it will no longer supply refinancing of maturing bonds. The rates charged by the market for new issuance will be far higher than is currently being experienced, and certain countries may even need an ECB guarantee to be able to enter the market.
While the battle to curb and eventually control Covid-19 is taking preference, the financial issues will go on for years and could bring significant changes to the fabric of the European Union.
The euro is still pressured despite days when it appears to recover. This is clearly a factor of the volatility of the dollar index.
Yesterday, the single currency rose to a high of 1.1368, closing at 1.1348. It had earlier fallen to a low of 1.1273.
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.”