5 May 2022: Borrowing costs adding to crisis

Borrowing costs adding to crisis

5th May: Highlights

  • Sunak facing another test of his abilities
  • Powell predicts softish landing
  • Probable tightening sends borrowing costs soaring

Halifax lets the cat out of the bag

Having been labelled the nation’s saviour following his efforts to provide support to those furloughed during the pandemic, Chancellor of the Exchequer Rishi Sunak is now facing another challenge as he is pressured to provide similar support as the country reels from the cost-of-living crisis.

The rising price of energy has been a major contributor to the crisis, and the Government, in the shape of both the Prime Minister and Chancellor, have both been unswerving in their comments about their inability to do anything about the issue which is clearly out of their hands.

They have, however, been heavily criticized for refusing to place a tax on the windfall profits being made by the UK’s energy companies. It is as easy to understand Sunak’s logic as it is to comprehend why the opposition Labour Party is exerting such pressure for the tax to be introduced.

Labour has no relationship with big business, and would happily introduce permanent taxation on all business which it feels made profits that it, as sole arbiter, believes to be excessive.

Sunak’s only advice may be to batten down the hatches, as the country’s emergence from the pandemic has unleashed a tsunami of inflation that has been further exacerbated by the conflict in Ukraine that has turbocharged rises in the cost of both energy and foodstuffs.

Today, the Bank of England will hike interest rates in a move that will certainly be labelled a dovish hike. Another name for it could be an apologetic hike. In order to make an effort to bring inflation back under control, it may be that Andrew Bailey and his colleagues on the MPC will have to crash the economy.

The well known UK banking institution, Halifax, appears to have let the cat out of the bag, by sending an email to its customers yesterday, confirming that the Bank has raised interest rates. Someone clearly got a little ahead of themselves.

It is doubtful that a hike of twenty-five basis points will do much more than place a plaster on rising prices, but the Bank has to be seen to be doing something, no matter how meaningful, or otherwise, it appears to be.

Half the nation will go to the polls today as local elections take place. These tend to have little bearing on what votes would do at a General Election.

The nationalist parties in Scotland, Wales and Northern Ireland tend to fare better as voters feel they are better connected at a local level.

While the Labour Party will look to translate any gains they make into a national surge in support, it is likely the Conservatives will need to hunker down until the storm passes, something that they have become adept at in recent months.

The pound received a boost in the aftermath of the interest rate decision in the U.S. It rose to a high of 1.2638 as the FOMC hiked rates and closed at 1.2628.

This show of strength is likely to be short-lived unless the MPC does something today to shock the market.

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Fed hikes and will begin balance sheet reduction next month

As expected, the dollar suffered a corrective, sell the fact, fall as the FOMC agreed to a hike of fifty basis points at its meeting that concluded last evening.

In his post decision press conference and question and answer session, Fed Chairman Jerome Powell also confirmed that the Federal Reserve will commence the reduction of its balance sheet, which was swelled by asset purchases made to add liquidity during the Pandemic, next month.

Overall, the tone of the comments backed the decision perfectly, and backed up the Fed’s decision to hike.

Powell commented that the committee believes that the economy can handle tighter policy, a view backed up by Treasury secretary Janet Yellen earlier in the day. These comments may be in reaction to both Powell and Yellen having had sight of advance copies of the April employment report that will be released tomorrow.

Powell believes that the economy is well positioned to handle tighter policy. He went on to say that a rise in the employment participation rate will see a further increase in the headline NFP number.

Powell predicted that the economy will experience a softish landing, although he believes that there are still several imponderables to be seen before any firm outlook can be predicted. One issue is the continued rise in wages, which is adding to inflationary pressures. As supply and demand come back into balance, wage inflation will moderate.

Given the projections made by the economics team at the Fed, seventy-five basis point increases are not currently being considered. It is unlikely that the Fed would see enough reaction in the economy to yesterday’s hike, a further fifty-point hike at the next meeting is already considered a certainty.

He reiterated that the FOMC understands the pain of high inflation, and it is its job to make sure the current level doesn’t become entrenched.

It remains a possibility that interest rates may have to exceed what is considered the neutral level in order to finally bring inflation under control, and it will be some time before rates are brought back to pre-Pandemic levels.

While plenty has changed due to the Pandemic and the conflict in Ukraine, the basic role of Central banks to control inflation and promote growth have not.

The dollar index performed a brief correction as Several long positions were liquidated post-FOMC. It fell to a low of 102.45, closing at 102.50. It is unlikely that this shallow correction will develop into anything else as the divergence between interest rates in the U.S. and the rest of the G7 is not expected to do anything other than widen.

EU to prohibit Russian energy supplies within six months

Over the three months of the conflict in Ukraine, EU Commission President Ursula von der Leyen has been somewhat conspicuous by her absence.

It may be that she has seen that the effect of the conflict has meant more to some nations of the EU than others, and this is probably true. However, the Union has to remain united in its foreign policy as one of the main pillars of its existence.

Von der Leyen emerged yesterday and confirmed that the EU would ban all purchases of energy from Russia within six months.

This was not new news, since a similar announcement had been made a month ago and had received mixed reactions. In fact, the German Chancellor has already gone on record as saying that such a ban may be impossible for his country to comply with.

The Ukrainian President has labelled purchases of Russian energy to be a war crime.

As predicted, retail sales in the Eurozone collapsed in APRIL as the effect of the continued loosening of restrictions collided with the economic reality of the conflict.

The result was a fall in sales from an upwardly revised 5.2% in March to 0.8% in April. Month on month sales actually declined by 0.4%.

The data brings stagflation a step closer as there has been no action to bring down inflation, while the economy slides into stagnation.

It will make any action a bitter pill for the ECB to swallow, since it will hit the weaker nations of the Union hard if interest rates are raised.

This will bring the old adage of one size fitting all into sharp focus, as these nations have in the past, been able to cope with higher inflation, but their ability to borrow their way out of such crises no longer exists.

The data released yesterday showed rising inflation is dampening any hope of growth in spending being seen.

The euro saw a moderate correction in the wake of the FOMC decision. It rose to a high of 1.0631 and settled back to close at 1.0622. This is likely to be only a short period of reprise for the single currency, indeed it may already be over, and the path to parity continues to beckon.

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.”