4 March 2022: Record inflation fails to hit growth

Record inflation fails to hit growth

4th March: Highlights

  • Inflation is still a concern, but the economy grew in February
  • Initial jobless claims fall by 18k
  • Unemployment under 7% for the first time ever

End of Plan B and the removal of restrictions boosts growth

The UK has faced several challenges since it left the European Union. Brexit itself supplied numerous challenges and continues to do so. The Coronavirus Pandemic threatened to cripple the economy, but the discovery of an effective vaccine provided the country with the means to bounce back.

If the unbelievably poor judgement of many members of the Government, including the Prime Minister, can be put aside for a moment, its performance in coping with such an unprecedented event should be considered to have been as good as could have been expected.

With the benefit of hindsight, the first lockdowns should have been enforced sooner and the first attempt at reopening was a little premature, but overall, only history will tell the story.

Now, with restrictions having been completely removed, there has not been a significant spike in new infections and the NHS is coping.

Inflation has risen significantly since first beginning to rise last summer, and it is now obvious that the Bank of England should have acted sooner to curb its advance rather than glibly labelling it transitory due mainly to the bottlenecks that developed in transport that led to shortages of finished goods, raw materials and spare parts.

The Bank of England, having hiked rates twice, now faces the dilemma of an economy that will begin to slow once the beneficial effect of the reopening wears off.

Inflation continues to rise and has been predicted to reach 7.5% by the end of next month.

The first batch of data for the economy shows that the country performed well in February, but now it faces further headwinds in the shape of the conflict taking place in Ukraine.

The fear is that if Vladimir Putin is successful in subduing Ukraine, he may be emboldened to continue his adventure and threaten the Baltic States. This would raise the stakes enormously since Estonia, Latvia and Lithuania are NATO members. Any threat to those nations would force the West into action.

The next six months will be critical for the UK economy. The Central bank will only get one opportunity to get it right, otherwise the expected downturn could become a damaging recession with the added threat of inflation remaining well above the Government’s target.

Yesterday, the pound continued its topsy-turvy performance within a well-defined range. It fell to a low of 1.3318 and closed at 1.3338.

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Economic reaction to conflict may drive Fed concern

Today’s release of the February employment report is predicted to continue the optimism that was delivered by January’s data, where the economy delivered 467k new jobs.

Market analysts predict another 400k new jobs for February, although in truth it is impossible, due to the nature of the data, for an accurate prediction to be made.

The headline non-farm payrolls are made up of a number of imponderables and estimates.

The market is still being mainly driven by the fall in risk appetite since the Russian invasion of Ukraine. This has led the dollar index higher, possibly to levels that are unjustified by the performance of the economy.

Outside the conflict, the outcome of the next FOMC meeting that will take place on March15/16 provides traders with an opportunity to express their opinion.

It is now certain, barring an unprecedented incident between now and then, that the Fed will raise interest rates. The level of the increase is what is adding to volatility.

Speech made by Regional Federal Reserve Presidents over the past few weeks have been driven not only by their individual opinions, but the performance of their economies that have illustrated the patchy nature of the recovery.

In some States the Omicron virus is still prevalent and despite its milder effect than earlier strains, healthcare services are still feeling the pressure.

In his State of the Union speech earlier in the week, President Biden confirmed what is obvious, that the endemic is still a threat, while the conflict in Ukraine threatens to disrupt the global economy.

Overnight, the Senate passed a bill ending the Covid-19 national emergency. The vote took place on Party lines and was passed 48-47, with five absentees.

President Biden and his staff will now be able to concentrate solely on the situation in Eastern Europe.

Jerome Powell, ending his two-day testament to Congress, accepted that the Central bank should have acted sooner to head off rising inflation. Powell sees small amounts of progress with supply chains, but they will be overshadowed by the conflict.

The shortage of workers that has been mostly attributed to the lingering effects of the pandemic should improve rapidly, but any increase in the level of wage demands is yet to feed into consumer inflation.

The dollar index continues to receive unwarranted benefits from risk aversion.

Yesterday, it rose to a high of 97.95, closing at 95.72. Overnight, it breached the 98 level briefly on news that a nuclear power station in Ukraine had come under fire and is on fire.

Central Bank ready to ensure plentiful liquidity

Christine Lagarde made a brief statement about the conflict in Ukraine. She commented that this is a dark moment for Europe. She went on to say that the ECB is closely monitoring the evolving situation. It will conduct a comprehensive assessment of the economic outlook, which will include these latest developments, and which will form the basis of its policy meeting on 10 March.

There is little expectation of any change to the current situation at next week’s meeting, although there is bound to be pressure from Germany in particular, since it saw inflation reach a high of 5.3% in February.

Inflation in the Eurozone is certain to be affected by the tightness of the labour market, where unemployment fell below 7% in January for the first time ever.

Increased wage demands due to rising inflation are so far not feeding through into the consumer price index, but this will begin soon as the price of energy continues to rise.

With Germany importing 60% of its gas from Russia, there is palpable tension about how this will play out in the coming months.

In keeping with the UK, there has been a surge in economic activity as Coronavirus restrictions have been eased across the Eurozone. The composite index of services and manufacturing output rose from 52.3 in January to 55.5 last month.

In Germany, output reached a six-month high of 55.6, but this was something of a disappointment since it was below the original flash estimate of 56.2

This data preceded the conflict in Ukraine. On a year-to-year basis, the conflict is expected to cut GDP by around a half of one percent.

Costs continue to rise which add to fears of rising inflation which, for now, is only affected the supply side of the economy.

Russia has so far not reacted to the sanctions that have put in place that are expected to hit both the Russian economy and numerous individual Putin allies.

There have been calls for the European Union to withdraw as much as possible from buying oil and gas from Russia. Given the tight markets globally this will be both difficult and costly.

The euro continued to plot a path towards the 1.10 level yesterday. It fell to a low of 1.1033, closing at 1.1063. Overnight it has fallen to 1.1010 in reaction to events in Kyiv.

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.”