A Rock and a Hard Place
January 31st: Highlights
- Sterling driven by contrasting pressures
- Federal reserve meeting to calm dollar concerns
- ECB rate policy set to be tested by German inflation.
Consumers hold the key in the U.K
Today we see wild excitement in markets created by 25 basis point (0.25%) changes in interest rates pored over by analysts for weeks in advance. Times have, indeed, changed
It doesn’t pay to get too nostalgic. The consumer has become the major driver of the U.K. economy as manufacturing has become the “final export”.
Consumer confidence has held up well following the Brexit vote. So far, however, there is little that has changed to make the consumer change his habits.
That may be about to change.
Inflation, a nasty virus that can grip an economy and send it into oblivion (witness 1920’s Germany and 1990’s Zimbabwe) is coming. The near 20% fall in the value of the pound since June 23rd will bring price pressures that will be dealt with by the Bank of England. Inflation is one of the few forward looking indices that Central Banks have to work with. The remit of the independent Bank of England is to ensure that inflationary targets two years hence are met.
It had been expected that interest rates in the U.K would remain on hold until 2019 but that outlook is having to be revisited. Asset purchases, a policy which adds funds to the economy and therefore cuts “real” interest rates are likely to be reined in in the next two quarters.
Sterling is in a relatively benign phase right now. Traders are loathe to drive it too much lower given the size of its fall already. The 1.20 area is seen as the “low-water-mark”.
So consumers, keep spending, do your bit to maintain the economy. The time for belt-tightening may not be too far away!
Inflation outlook in Germany highlights two speed Europe.
The “one size fits all” Eurozone doesn’t work economically. Historically high interest rate high inflation economies like Spain and Italy cannot cope with the straightjacket that is German fiscal and monetary policy. Equally it is impossible for the Germans to cope with loose monetary policy that drives those “Club-Med” economies.
Ok, off the soap box.
Inflation in Germany is likely to print a reading of 2% in its latest release which is the ECB’s long term goal. The economic cycle for the Eurozone as a whole dictates that the Central Bank is nowhere near a rate hike so Germany will have to live with inflation higher than they want/need with the constituent fears that brings.
The Euro is starting to firm against the dollar driven by the possibility that ECB President Mario Draghi may be forced to act. He speaks tomorrow and commentators will hang on every word.
It is hard to see where domestic politics sits within the Federal European framework but with three elections this year in France, The Netherlands and Germany populist EU bashing could become a major component.
In France the scene became a little clearer with the ruling socialists deciding on Benoit Hamon as their candidate. This all seems a little academic with opinion polls overwhelmingly pointing to a centre right Government being likely as President Hollande’s popularity sinks lower and lower.
Trump’s Giant Shadow
Donald Trump arrived on the global scene like a whirlwind throwing out executive orders at an alarming rate.
The dollar had reacted positively to his election with traders seeing economic stimulus and domestic growth inducing policies as his central theme. However as we see the reality of his America First protectionist platform the outlook becomes a little less clear. Watch this space
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.”