31 March 2023: Deciding next policy move tough


  • Housing market downturn, a concern for the Bank of England
  • Financial near-death experience may bring recession
  • ECB has more to do as inflation proves sticky
GBP – Market Commentary

High core inflation but falling headline brings difficulties

The Bank of England will face a difficult decision at its next monetary policy committee meeting. Although headline inflation is moving in the right direction, the core remains uncomfortably high and is showing less inclination to be driven by tighter monetary policy.

Catherine Mann, commented in a speech yesterday that the Central Bank will need to find other ways to affect underlying inflation and that will make it difficult to decide monetary policy as the year progresses.

With energy prices on a downward slope, headline inflation is continuing to fall, and the between headline and core prices is narrowing. The prices of services and goods remain in an uptrend, which could be an issue going forward.

The mild winter in Europe has seen demand for energy decrease. Although the high cost of energy fed through into almost every area of consumer spending, that pressure is now decreasing.

The 2% target for inflation is set in relation to the headline figure, and this will be extremely difficult to meet given a persistent and unmoving core.

Recent data published for various sectors of the housing market continues to show a significant slowdown as households show they are lacking the confidence to take the plunge and move house.

There is something of a Catch 22 situation developing in which the equity that homeowners have in the homes in gradually being eroded but since the rise in prices is also slowing, they are encouraged to wait and see, since the additional costs of moving house will be in addition to being immediately in a situation where they may have negative equity in their new home as prices turn negative.

The knock-on effect of a slowdown in the housing market is one of the factors that will encourage the Bank of England to end its programme of rate hikes.

It is not only consumers who are being affected by high interest rates relative to the recent past. Small businesses are seeing the cost of working capital facilities increase and this affects their ability to invest in longer term projects such as new plant and machinery.

The proximity of the neutral rate at which short-term interest rates are neither restrictive nor supportive means that the decision of the MPC on whether one more hike is really necessary will have a far more significant effect than most of the previous eleven consecutive rate increases.

The pound remains well-supported, and is approaching a major resistance level against the dollar. It is questionable whether it will have the momentum to break the 1.2430 level without experiencing a mild correction first. Yesterday, it reached a high of 1.2393, closing at 1.2388.

Next week will be shortened by the Easter holiday, but there are still some significant data releases before the four-day break.

The Halifax House Price Index will be published, as well as preliminary data for both manufacturing and services output for March.

USD – Market Commentary

Four-week average closes on watershed figure of 200k

Although it doesn’t publicize the fact, the FOMC is likely more affected by the jobs market than any other sector of the economy.

Analysts have been expecting a turnaround in the number of new jobs created almost every month for the past two quarters. As long as workers see their ability to earn a larger pay packet for doing essentially the same job for a different employer, the market will remain buoyant, even if it can no longer be considered red-hot.

Over the past few months, the weekly jobless claims data has shown a gradual fall and the four-week average has fallen well below the 200k level, which is informally considered to be either positive or negative for the entire employment market.

The release of this data yesterday, for the week ending March 24th, showed what may turn out to be a significant increase. New claims rose to 198k from 191k, the previous week, close to the four-week average which currently stands at 198.2k.

Next week will see the release of the March employment report. No one can dispute that the first quarter of 2023 has been characterized by a strong jobs market, which justifies the FOMCs decision to continue to raise rates.

Speaking yesterday, Neel Kashkari, the President of the Minneapolis Federal Reserve, was uncharacteristically hawkish in his desire to see inflation fall. He feels that unless inflation is brought down close to target, the economy won’t be able to grow to pre-pandemic levels.

His own team in Minneapolis is currently studying the effect of interest rate risk on banks, and he is concerned that this may take longer than is realized by the market to feed through into the regional market.

Mary Daly, the President of the San Francisco Fed., is facing severe criticism of the seeming lack of oversight of Silicon Valley Bank, the collapse of which precipitated the current liquidity crisis.

While she has been one of Jerome Powell’s staunchest supporters over the past year, she is now accused of taking her eye off the ball with regard to banking supervision, possibly blind sided by the sector’s profitability.

The economy is still not certain to avoid a recession, but if one occurs it is likely to be no more than a technical two quarter contraction, which the FOMC probably won’t take too seriously.

The dollar index closed last evening perilously close to a major level of support. It fell to a low of 102.38 and closed at 102.42. The line of support is at 102.25 and having fallen for eight of the past ten sessions, the index may see a minor correction before testing the support.

EUR – Market Commentary

Public shows faith in ECB’s ability to drive inflation down

Consumer confidence across the entire Eurozone remained unchanged in March. While this is encouraging, it also reflects frustration over the fact that despite falls in the wholesale price of energy, inflation remains uncomfortably high.

Any mystery surrounding meetings of the Governing Council of the ECB has been taken away by the level of advance guidance that is being given to the markets in the weeks leading up to the decision on monetary policy.

The next meeting that will be held on May 4th will almost certainly agree on a further rate increase, although there may be some question about the magnitude of the increase, which may be either twenty-five or fifty basis points.

The forced sale of Credit Suisse has not as yet seen any contagion, although both Joachim Nagel and Olaf Schmidt felt the need to verbally support Deutsche Bank after its shares fell 14% last week.

Should there be any further pressure seen on liquidity, the Central Bank may feel it necessary to send a signal to the markets of its concern.

Although in the grand scheme, twenty-five basis points are neither here nor there, the ECB will want the markets to understand that inflation remains its primary concern, although banking liquidity also needs to be addressed.

The ECB is expected to continue to raise interest rates, right through the second quartet and possibly even beyond if inflation remains, in Christine Lagarde’s words, sticky.

That will of course be subject to there being no contagion felt from the recent turmoil.

Given the actions of the European Union in the past when faced with the 2012 government debt crisis, investors may be forgiven for being wary.

That concern is not being felt in the path of the Euro. Yesterday, it continued its recent rally, threatening resistance at 1.0915. It reached a high of 1.0926 before succumbing to short term profit-taking, which led it to close at 1.0905.

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.