4 January 2023: Severe headwinds facing economy


  • Economic plight could be worse than the Pandemic
  • Soft Landing improbable
  • German inflation falls below 10%
GBP – Market Commentary

Any recovery from what is to come could last until election!

Several reports have been released by NGOs, financial institutions and investment houses providing their prognosis for the UK economy over the next twelve months.

The verdict is consistently dire, with no one seeing any reason to doubt the Governor of the Bank of England’s forecast that the economy will fall into a fairly deep and long recession which will last at least five quarters beginning in the fourth quarter of 2022.

The economy is clearly facing a number of factors that are difficult to ignore. First, inflation continues to appear to be out of control despite two of the main contributors to headline inflation; Forecourt fuel prices and the wholesale cost of gas beginning to fall.

The price of gas has fallen to a level not seen since the war in Ukraine started, while the forecourt price of a litre of petrol has dropped to around 150p as the oil price hovers around $80 per barrel.

However, as the Bank of England continues to hike interest rates, mortgage payments will continue to rise, while the new financial year will bring increases in council tax driving core inflation higher.

Inflation is also exacerbated by a labour shortage in several sectors, but particularly transport and hospitality, due to the ongoing restrictions driven by Brexit.

Consumer confidence is at multi eyes already and is only going to get worse, while a fall in manufacturing output is gathering momentum.

The RMT union has received a mandate from its members to call strikes right through May from rail workers, as the crisis in the NHS deepens with the Winter flu outbreak and an upsurge in cases of Coronavirus placing an increasing strain on hospital A&E departments.

The only positive in this sea of gloom is the unemployment rate, which has fallen to 3.7%, although it will rise as the economy slows, possibly reaching 5% or even 6%. Historically, this is still a low number, but the entire makeup of the economy has radically changed since Brexit and the Pandemic.

The pound has started the year quietly as the market awaits the release of the minutes from the December FOMC meeting. It mostly trod water yesterday although it did fall below the important 1.20 level. It reached a low of 1.1900, closing at 1.1973.

USD – Market Commentary

Market sees a dovish Fed pushing the dollar lower

The consensus view of the release of the Minutes of the FOMC meeting which was held on December 14th is that there will be little change in sentiment, The committee will continue with its tightening bias while remaining driven by data.

The economic projections delivered at the last meeting were relatively positive. While accepting that economic performance will be below trend, there are unlikely to be any Fed Presidents who see a recession in their who see a recession in their regions.

President Biden signed into law a Bill blocking a damaging strike by rail workers, although some concessions in the area of sick leave were granted. There remains a degree of militancy as the unions representing rail workers continue to try to bring pressure to bear for greater reforms, through Congress.

The decision of the Chinese state to lift restrictions relating to Covid-19 has raised the spectre of another Pandemic in the U.S.

Travellers from mainland China will have to undergo a test upon arrival or be able to produce a negative test certificate.

While the Fed’s base case does not include a recession, several prominent businessmen disagree with their view. The CEOs of Amazon, Tesla, and Citibank, while not actively predicting an outright recession, are all concerned about a painful downturn in economic activity.

Given the global nature of the output and profitability of these companies, they each hope that they are sufficiently diversified to weather any storm in their home markets.

The release of the December employment report on Friday may be a watershed for the Fed. As short-term interest rates have turned restrictive, several commentators have predicted a significant downturn in the headline NFP figure.

The average of the top financial institutions predictions is for 200k new jobs to have been created in December, a significant fall, but with interest rates having gone from zero to 4.5% over the past months such a drop is reasonable. The range of predictions is from 1.75k to 2.30k.

The dollar index saw its largest daily gain since mid-December yesterday. It rose to a high of 104.86 and closed at 104.68.

EUR – Market Commentary

But, inflation at 9.6% won’t please Bundesbank

The small green shoots of a recovery were seen in the German economy were seen yesterday, ending a dismal run that has driven frugal citizens to despair.

They have had to put up with extremely low interest rates in their savings while inflation has growth to multi-decade highs,

While the fall in inflation that was announced yesterday, from 10% to 8.6% was significant in its own right there is still a significant distance for it to travel until the Bundesbank and Finance Ministry can consider themselves satisfied.

Employment data was also released and the rate of unemployment fell again, which will have also cheered workers in a month in which good news is often at a premium.

One concern that the Bundesbank President will have, is that should the fall in inflation be repeated across the entire Eurozone, the ECB may be tempted to taper the size of its future rate hikes which the German Central Bank among others consider to be vital if the fight against rising prices is to be won.

Dr. Joachim Nagel, the present President of the Bundesbank spoke recently of his view that the ECB is a long way from its inflation target. Before the target was reviewed, it was set at 2% and paid no heed to the period of time it spent in the recent past well below the target.

Following a review by the ECB President and her economics team, the target was revised to be an average of 2% that was time sensitive,

Several countries, most notably Italy, will have been also cheered by yesterday’s German Inflation data as they believe that the ECB was wrong to inflict a fifty-basis point hike upon the entire region last month so will see an opportunity for the next hike to be no more than twenty-five basis points.

There is no guarantee that inflation data for the entire Eurozone will follow the same path as in Germany, in particular since Germany created a number of fiscal initiatives that have not been applied across the Eurozone.

Furthermore, core inflation remains uncomfortably high in several economies, which may also skew the numbers.

The euro suffered yesterday, on speculation that the ECB may be persuaded to taper future interest rate rises.

It fell to a low of 1.0519, closing at 1.0558. While the move was insignificant in itself, it showed the sentiment of the market for when the ECB removes its tightening bias.

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.