- Bank hikes rates for tenth successive meeting
- Premature to claim victory over inflation
- Lagarde calls on Governments to dial back energy Support
Bank of England forecasts shallower and shorter recession
Not being prone to over exaggeration during his close to three years as Governor, Bailey is considered by the markets to be a pragmatic and cautious Governor.
For this reason, the financial markets place a great deal of confidence in his comments.
Although the IMF reported this week that it sees the UK suffering from a downturn that is unmatched by any other developed economy, Bailey studiously avoided referencing their report in his own statement.
The MPC saw fit to hike rates by fifty basis points, the tenth consecutive meeting at which they have tightened monetary policy.
With the base rate now standing at 4% speculation has begun about how much further rates need to be increased to bring inflation under control while avoiding additional damage to the economy which is fragile at best.
In all probability two further fifty point hikes should suffice, since a base rate of 5% will certainly be sufficient to dampen demand and bring inflation, which is only falling very slowly, under control.
Although his comments were not particularly upbeat, they did contain a dose of realism. He believes that although the recession won’t last longer than the end of this year, the economy won’t fully recover from the damage that has been done from Brexit, the Pandemic and the Truss experiment, as well as the strikes that are affecting the economy currently until 2026.
By that time the election will take place and although the opposition Labour Party, which is currently considered a shoo-in, is not expected to bring radical change, the fact that there is likely to be a change in attitude will reap its own rewards for the country.
Now that the latest round of Central Bank meetings is out of the way, the stage should be set for the currency market to develop medium term trends. Both the ECB and Bank of England have further to go in tightening monetary policy with little change likely in this quarter, which it appears that the FOMC is close to the end of its current cycle.
In terms of Sterling, there should be a period of marginal strength as long as conditions remain as they are. A reasonable target for the pound against the dollar is 1.2660, although it will need to clear resistance around 1,2430 first.
Yesterday, the pound rose to a high of 1.2395 and closed at 1.2374.
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Fed President remains committed to taking inflation to 2%
Powell has been firm in his belief that the Central Bank remains data driven, and he is not necessarily dominated by absolutes.
For that reason, if rates have to reach five point five or even six percent, then it can be justified by the strength (or otherwise) of the economy.
It is not unusual for the Chairman to consider different dynamics when it comes to monetary policy than his colleagues from Regional Federal Reserves. It is likely that being on the ground, that they see more of what is happening at a grassroots level.
President Biden thanked the outgoing Chairman of the White House Economic Advisory Committee, Brian Deese, for his work in establishing the Administration’s vision for economic stability.
There has been no announcement concerning his replacement yet, but Fed Deputy Chairman, Lael Brainard, is strongly tipped to replace Deese. It would be a sensible move for the likely next Chairman of the Central Bank, as it would allow her access to what the Administration and Treasury are thinking moving forward.
Asset markets began to gain strength from the perception that the smaller hike in interest rates that happened on Wednesday is a prelude to the Central Bank pausing its current cycle of hikes.
Although Powell gave no indication of this happening yet, in fact, he hinted at the opposite, today’s employment report for January will be yet another piece of the jigsaw, albeit a large piece.
There is no way of accurately predicting the data, and it has very little correlation with other employment related numbers that have been published this week. Despite this, several commentators are willing to put their neck on the block.
The average of those predictions is for 180k new jobs to have been created.
The dollar is likely to be under pressure as the Fed is probably/possibly/likely to be close to ending hiking interest rates. Yesterday, the dollar index reversed almost entirely its fall from Wednesday, which can be considered a knee-jerk reaction to the Fed’s statement.
It rose to a high of 101.91 and closed at 101.74.
Right wing Government wants to change things from within
When Italians voted for the most right wing Government since the war, it was assumed to be a prelude to a period of Italian disobedience towards Brussels and possibly Italexit.
What is interesting is that what has occurred has been a far more pragmatic approach from Rome, in which it is clear that Italians would prefer to be in the tent looking out than outside the tent looking in.
The Italian Government has even adopted a word to describe Brexit. It is Bregret, since it believes that successive Governments in Westminster will live to regret going it alone in very challenging economic conditions.
There has been little comment from Rome about the rate hike of fifty basis points which was agreed yesterday. With the Italian economy failing to recover from the Pandemic induced mini-recession as well as its neighbours, in particular Spain, Brussels and Frankfurt have become easy targets for Roman ire.
Italy has a long history of high government borrowings and budget deficits well in excess of the accepted norm of 3% of GDP. The economy is not recovering as well as it should due to the spears between German and Italian government bonds widening to close to crisis levels.
In her statement following yesterday’s rate decision, the ECB President, Christine Lagarde, spoke of her wish that individual eurozone nations begin to dial back the level of support they are providing to cover high energy bills.
This support adds to inflation and with the wholesale price of gas having moderated recently despite being sensitive to any escalation of the situation in Ukraine, she believes the cost to ordinary citizens of rising inflation outweighs the benefit.
The ECB raised rates to 2.5% yesterday, which remains well below the level needed to dampen down demand. The markets believe that rates need to be around 4% or possibly higher to have the necessary effect.
That will have a highly beneficial effect on the single currency, which touched 1.10 versus the dollar in the immediate aftermath of the FOMC decision. While a fifty point hike was almost certain to happen, its effect wasn’t particularly radical, but the euro should be set fair for further gains.
Yesterday, it fell back to a low of 1.,0885 and closed at 1.0913 as it began a period of consolidation as the market awaits today’s employment report from Washington.
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02 Feb - 03 Feb 2023
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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.