30 June 2023: Bank of England won’t “sacrifice” workers

Andrew Bailey has defended the fifty point rate hike agreed by the MPC last week, while at the same time tried to explain to the market that it is not the Central Bank’s goal to see unemployment rise, although the committee is well aware that firms will need to “rationalize” their workforce as they experience a drop-off in demand.

Headline inflation is still “far too high”, and the Bank believed that it had to make a statement of serious intent when the May price data was released.

Having voted for a twenty-five pointy hike last week, Silvana Tenreyro, speaking at the ECB annual conference in Portugal, shared the belief that she holds with another independent member of the MPC, that pay growth and core inflation are set to slow considerably and rather than further hikes, the Bank of England may be forced to cut rates later in the year to stimulate the economy.

That is, however, not a view held by a majority of the MPC, who acknowledge that their actions will slow the economy, but not to such an extent that it will contract over an extended period.

Interest rates may have now reached a “neutral position” where they are neither supportive nor restricting demand.

The opinions of Tenreyro, Swati Dhingra and the rest of the MPC diverge significantly over future hikes. The two independent members both believe that the lag in tightening monetary policy means that the economy may have a significant slowdown “in the pipeline”, even if it were to end rate hikes immediately.

Huw Pill, the Bank’s Chief Economist, made a speech yesterday which was his first since he attracted criticism for urging people to accept they are poorer, in an earlier speech.

He was called upon to defend himself again, this time over the Bank’s record in forecasting future economic developments, for which he is ultimately responsible. In his defence, this is a thankless task with several groups “queuing up” to second guess his predictions, often with the benefit of hindsight.

Pill defended his record yesterday by expanding on the difficulty of making forecasts with the current level of uncertainty that exists around inflation, employment and growth.

The pound consolidated its fall from the previous day as it fell to a low of 1.2591 and closed at 1.2614 yesterday.

Next week, data for output in the manufacturing, services and construction sectors will be published, as well as numbers for house prices. The housing numbers will provide a clue to how issues being faced by the mortgage market have translated into activity.

Jerome Powell took a break from the constant barrage of questions he receives daily about future monetary policy to discuss the Feds plans for protecting investors and depositors from future bank failures.

He was initially quite defensive when asked if the tightening of monetary policy that has taken place over the past fifteen months was a factor in three banks failing earlier this year.

He acknowledged that the failures underscore the need for tighter regulation as Silicon Valley Bank and two other midsized lenders had to be “bailed out”.

He went on to answer criticisms the Fed received from the large “money-centre banks”, most of which are headquartered in Wall Street, who railed against further regulation and additional capital requirements since they, as a group, have not experienced any difficulties since the failure of Lehman Brothers in 2008, which precipitated the separation of commercial and investment banking.

Powell agreed that the past few months would have been far more difficult to manage if the largest banks had been “undercapitalized”.

The release of the final cut of first-quarter GDP, which was published yesterday, supplied a significant surprise to the markets. Between January and March, the economy grew by 2% on a year-on-year basis, almost double what had previously been released.

With consumer confidence having grown substantially so far this year, with expectations now well above the level they were at prior to the Pandemic, it was perhaps hardly surprising that consumer spending led the way in increased activity.

With the Fed trying to cool demand by raising interest rates, the data showed the resilience of not just consumers, but the economy in general.

The number of companies expressing concern about a recession coming later in the year has fallen dramatically. There is a new-found optimism over the next eighteen months as the country prepares for a Presidential election.

The dollar index continued its recent rally, reaching 103.43 and closing at 103.35.

Next week will see the release of the June employment report. Those foolhardy enough to make a prediction about the headline number of new jobs created and forecasting a 200k increase in non-farm payrolls.

Before that, the minutes of the latest FOMC meeting will be released. They will be of particular interest as they will show which members of the committee were against a pause in rate hikes.

The hawks on the ECB’s Governing Council appear to have found a new “scapegoat” for their infatuation with hiking interest rates. A succession of hawkish central bankers, headed by the Bank’s President, Christine Lagarde, are blaming the excessive profits being made by companies domiciled in the Eurozone.

Lagarde went even further at the ECB’s Annual Conference by saying that she believes profits are a bigger factor than wages in creating inflation.

One person who has joined the “dovish faction” is ECB Chief Economist Philip Lane, who has warned the market against being too confident in “pricing-in” further hikes in interest rates at the next two ECB meetings.

Although both headline and core inflation remain well above the ECB’s target of 2%, Lane believes that the Eurozone is in something of an “adjustment phase”.

It is well known that changes in monetary policy lag the economy, and the full effect of hikes made during this year is not being seen yet, while it remains to be seen if rates have now entered a restrictive phase.

Lane believes that even without a hike in September, interest rates in the region will remain “high” for some considerable time.

He feels that although satisfactory progress has been made, it will possibly be as long as two years before inflation is back to 2%.

Lane echoed the sentiments of Christine Lagarde in feeling that it is premature to declare victory in the fight against inflation.

The ECB has added four-hundred basis points in tightening in a little over a year, but some observers feel that it may be forced to cut rates as a nascent recession deepens towards the end of the year.

The euro continued the retreat it has sent over this week as the market reacted to stronger than expected U.S. GDP data.

It fell to a low of 1.0860 and closed at 1.0868.

Next week PMI data will be released for both individual c countries and the Eurozone as a whole. It is expected that the numbers will show further contraction in output as the recession deepens.

Have a great day!