4 August 2022: BoE may revise inflation forecast

BoE may revise inflation forecast

4th August: Highlights

  • Inflation could reach 15%
  • Economic data pushed thoughts of long-lasting recession back
  • Retail sales close to collapse as recession fears grow

GBP – Is the Bank making the situation worse?

The Bank of England’s Monetary Policy Committee has been meeting and will announce its decision on short term interest rates at lunchtime today. It is probable, but by no means certain, that the decision will be to hike by fifty basis points.

Almost as important as the decision on interest rates will be the release of the Bank’s projections for the economy.

This will provide advance guidance to the markets about the Bank’s expectations for growth and inflation over the rest of the third quarter. The most recent monetary policy summary predicted that inflation could reach 11%, but there is a real possibility that that will be revised upwards, possibly to as high as 15%.

Were that to be the case, the Bank would be certain to continue to raise rates.

That does seem to be an extreme view, particularly with the price of petrol having fallen recently. However, with Ofgem, the energy regulator, stating recently that the estimates for the rise in the energy cap in October are likely to be revised upwards, a further significant rise in inflation should not be discounted.

There has been severe criticism of the profits made by UK energy companies Shell and BP. When he was Chancellor, Rishi Sunak deliberated long and hard, but in the end decided to pass a windfall tax on energy companies for what he called at the time, excess profits.

However, in a recent question and answer session, Sunak’s rival to be the next Prime Minister, Liz Truss Truss rejected another such decision stating that it would send out the wrong message to the world, since the UK should be encouraging companies like Shell to invest in the UK.

Another former Chancellor, Sajid Javid, who himself was a candidate in the leadership election, declared his support for Truss yesterday. This was something of a surprise for two reasons.

First, the timing of his announcement provided another boost to her campaign, and second, it had always been assumed that he was more of a moderate akin to Sunak.

It is too early to say that the election has become a foregone conclusion, but it would now be a surprise if Sunak were to be able to win from his current position.

The pound has seen a fair amount of volatility this week, and that is set to continue in the aftermath of the MPC decision. Yesterday, it again attempted to rise above 1.22 versus the dollar, reaching a high of 1,2207, but it fell back to close at 1.2149.

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USD – Fed’s inflation measures, more harm than good?

Today’s release of data for job cuts is a traditional curtain raiser for the Employment report, which includes the headline Non-Farm payrolls.

The Challenger report on jobs cuts in corporations sets out the data by industry and geographical region. In June, there were 32.5k lay-offs. That was close to a 60% increase in June 2021.

Any significant rise in that figure later today will add further confirmation that the employment market is beginning to cool off, pointing to a drop in the headline figure in the July Employment report.

Today will also see the weekly release of data for jobless claims. The average number of claims has been creeping up. While this isn’t necessarily significant, the data always takes on greater significance during the first week of the month.

The four-week average currently stands at around 250k, although today’s figures are expected to be nearer 260k.

Data for output in non- manufacturing sectors was released yesterday, and showed that services are still expanding. This is another that the economy isn’t yet in inflation despite the contraction in overall GDP.

The visit to Taiwan by the Speaker of the House of Representatives, Nancy Pelosi, this week has set back U.S./ Chinese relations. Although it wasn’t formally sanctioned by the White House and Pelosi was careful to use the correct terminology to refer to the country, Beijing has reacted angrily in both word and deed.

During the visit, Chinese fighter jets entered Taiwanese airspace several times and Beijing announced live-fire exercises in six areas of the Straits of Taiwan, parts of which encroach upon Taiwan’s theoretical territorial waters.

Pelosi praised Taiwan’s efforts at democracy, but was careful not to encroach upon the ambiguity with which its nation status exists.

The dollar index is reacting to the drop in global risk appetite that has been under pressure due to the continued conflict in Ukraine and the increase in tension between the U.S. and China.

Yesterday, the index rose to a high of 106.82, closing at 106.40. The most significant area of resistance currently is around 107.20.

A challenge to this level will be possible should the Employment report point to continued rate hikes by the Fed.

EUR – Conditions to support indebted nations are still not agreed

Reports yesterday showed the stark condition of Germany’s industrial base, which may have to consider shutting vital industrial plants if the current gas shortage continues.

Contingency plans are being hastily prepared for what have been labelled unforeseeable consequences.

There is a real possibility that Germany will see a deep and lasting recession if Russia continues to reduce supplies. Were it to cut supply completely, the consequences would be catastrophic.

A spokesman for the German Energy Supply Authority spoke yesterday of the possible need for rationing already in order to protect the vulnerable and old.

German Chancellor Olaf Scholz based part of his election platform on promises to stop using coal-fired power stations and to drastically reduce the use of nuclear energy.

This may come back to haunt him, not because it is wrong as a long term strategy, but because the reliance on energy from outside the country has left it vulnerable.

The current agreement for Russia to supply gas, and to a lesser extent, oil to Germany was negotiated by Angela Merkel in, what is now considered to be, a naive attempt to bring Russia into the European fold.

Data released yesterday shows that the entire Eurozone economy is weakening at an ever-increasing rate. The composite PMI remains below the point which determines expansion or contraction, although it rose slightly.

Services output remains in expansion, but within the Eurozone this is not as significant a part of the economy as it is in the UK.

With economic growth flatlining, and there unlikely to be any short term fix to the escalating energy crisis, the ECB is facing a torrid time.

Not only will be it faced with having to justify a further rate increase at its next meeting, the details of the now tool designed to assist indebted nations in the spread they pay for funding in the capital markets. The more hawkish nations led by Germany and Austria are demanding assurances that they are not throwing good money after bad, should a scenario emerge where a default becomes a possibility.

The euro isn’t currently reflecting the economic reality of the Eurozone. It is probable that investors are waiting to pounce on any perceived strength in the currency.

Yesterday, the single currency was unchanged on the day at 1.0216 as the market remains transfixed by geopolitical risk.

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.”