30 March 2022: Bailey turns bearish on economy

Bailey turns bearish on economy

30th March: Highlights

  • Squeeze on household incomes could bring recession
  • Job switches are becoming more common
  • Lane injects a sense of realism

Russian invasion to slow down

It is tough to find any good news for the UK economy as the country leaves the Pandemic behind and begins the work of recovery. Workers are facing what the Bank of England Governor has called a historic shock to incomes.

The UK economy is primarily led by consumption. Consumers going out and making purchases keeps the country ticking over, so anything that creates stress for that sector quickly permeates through to the rest.

There is little doubt that Andrew Bailey is right in describing current conditions as historic.

The country had barely been able to complete its withdrawal from the European Union before the Pandemic hit, and now it faces an energy crisis not originally due to the conflict in Ukraine, but certainly exacerbated by it.

It is hard to imagine a scenario where an invading nation is so roundly condemned, yet the nations closest to the conflict are forced by circumstance to continue to trade with it. The fact that Russia had managed to skilfully make itself invaluable in supplying energy primarily to Europe had clearly been factored into President Putin’s plans as he considered the fallout from his actions.

While the UK’s direct import of energy from Russia is minimal, the rise in the price of oil and more especially gas has set back the country’s recovery and hit growth hard as it was beginning to pick up.

Now, there are suggestions that a recession could be on the horizon as the Central bank changes its stance from support for the economy to trying to battle rising inflation.

Economists are now predicting that the average level of inflation for the rest of the year could be around 8% despite the Bank of England being likely to hike rates at its next three meetings to bring the rate to 1.50. This would still be low in historical terms and may fail to tame rising prices.

The Bank of England finds itself in a difficult position. With the economy slowing down without any help yet inflation rising, MPC members find themselves in the position of being forced to apologize for hiking rates. These have been labeled as a series of dovish hikes that gives the impression that there is a lack of confidence in its own monetary policy.

A policy rate of 1.50% by the summer and inflation continuing to rise will see the pound suffer. Yesterday it was extremely volatile but failed to make substantial gains as risk appetite improved following the rumour of a potential breakthrough in talks between Russia and Ukraine.

It reached a high of 1.3159 but fell back to close just seven pips higher on the day at 1.3093.

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Recession or not? Only time will tell

Every economist, investor, trader, and economist in the U.S. and around the world seems to have a different view of the state of the U.S. economy. Even those who matter, The President, the Treasury Secretary and the FOMC, are hardly exuding confidence that the country will avoid a recession.

The FOMC believes that one of the most potent drivers of continually rising inflation has been the fact that workers are now finding themselves in such demand that they are able to easily switch jobs to take advantage of higher wages being offered to attract them.

Since late last year, the number of vacancies in the jobs market has hovered close to the record of 11.4 million set in December.

The number of Americans leaving jobs has now reached 3.4 million, with the vast majority of those moving to another position immediately and being paid more.

Last month, the headline NFP showed that 678k new jobs were created, but job openings only fell by 17k. That illustrates perfectly the dilemma faced by employers.

Before the Pandemic, there were often more people looking for work than openings available. In February, there were 1.8 jobs available for every unemployed worker. This has empowered the workforce to demand better pay and conditions, since they are heavily in demand.

The Fed Chairman now sees the link between quits and job openings as being a vital indicator of the employment market as the Fed tries to cool inflation.

The President of the Philadelphia Federal Reserve Patrick Harker spoke yesterday of the deliberate and methodical methods being used by the FOMC that are shaping monetary policy. The Central bank has been accused of rushing headlong into tightening policy, with talk of a reduction in the size of its balance sheet going hand in hand with higher rates.

This is a sea change from its previous policy regarding interest rates and its belief that the balance sheet reduction should follow the hike(s) in rates.

Data for consumer confidence was released yesterday, and the employment situation is likely to have contributed to a marginal rise. Confidence rose to 107 from 105.7 a month earlier. The present situation rose to 153 from 143, but future expectations were hit by the degree of uncertainty driven by higher fuel prices and the conflict in Ukraine.

The dollar index was hit hard by the news from talks being held in Turkey that Russia has offered to withdraw from its objective of taking Kyiv to concentrate on the Donbas region and Ukraine will consider itself neutral and withdraw any consideration of joining NATO.

The index fell to a low of 98.03, closing at 98.42. It has continued to lose ground overnight, currently (0500 BST) standing at 98.10

Economy facing a massive hit from war according to Lane

In contrast to the bullish outlook being presented by the ECB President Christine Lagarde, her colleague and the Bank’s Chief Economist, former Bank of Ireland Governor Philip Lane yesterday injected a sense of realism into the ongoing debate.

Lane spoke of his concerns about darkening sentiment across the region as the conflict in Ukraine continues to affect sentiment.

Significant and substantial falls in both consumer and corporate sentiment will drive the economy lower as inflation continues to rise. Lane drew back from mentioning stagflation following his boss’s recent affirmation that the data she is seeing shows that the economy will show a degree of growth this year.

Lane went on to say that the Eurozone may have to get used to heightened inflation, although most of the price increases that are being seen currently will fade away as normality, or some semblance of it, returns.

It is only a matter of time before momentum, the fact that inflation is higher month by month, begins to fade naturally, but engineering a fall may be more difficult to achieve.

Despite the latest data releases, Lane stands by the ECB’s latest forecast, which sees growth at 3.7% and inflation at 5.1% this year.

Given the continued reduction in the import of energy from Russia, it is hard to see prices falling sufficiently to make a major dent in the level of inflation.

A hike in rates, the ECB’s first in a decade, will be determined by the data and the Central bank will remain reactive.

While Christine Lagarde still favours support for those nations struggling for growth, her view is no doubt also driven by the effect of the conflict of those nations who lie in the closest proximity to the fighting.

Further sentiment indexes will be published later this morning.

Data for the Business climate and economic sentiment together with industrial and services confidence will be released. While in normal times, these would be considered secondary, sentiment is driving the current environment right across the whole economy.

Yesterday, the euro rallied strongly on hopes of a breakthrough in peace talks between Russia and Ukraine. It reached a high of 1.1137 and closed at 1.1087.

Have a great day!
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.”