6 August 2021: Stimulus unchanged despite inflation

Stimulus unchanged despite inflation

6th August: Highlights

  • Unwind of bond purchases to come sooner rather than later
  • Jobless claims continue to move in the right direction
  • Eurozone haunted by ghosts of past performance

Bank of England set to beginning tapering process

Yesterday’s meeting of the Bank of England’s Monetary Policy Committee confirmed that the process towards a reduction of support for the economy is about to begin.

The decision to leave interest rates unchanged at 0.1% was entirely predictable, while there had been a degree of speculation about the start of a reduction in the asset purchase scheme. In the end, it was left unchanged at £895 billion. There was just one dissenting vote. Inflation hawk Michael Saunders voted for a reduction in the level of asset purchases.

BoE Governor Andrew Bailey spoke at his press conference of the need for a modest tightening should the economy grow as expected. The ambiguity of that remark was not lost on analysts.

Bailey has been outspoken about the fact that he believes the recent rise in inflation is transitory.

Following yesterday’s meeting, he was a little less certain. He now believes that the key question for the MPC is whether inflation pressures are temporary. The view of the committee is that inflation will fall in the medium term, which is where their concern lies. They will mostly disregard short-term pressures driven by transient factors.

Bailey went on to say that the MPC concentrates on the bank rate as the main tool of monetary policy. The effect of a reduction of its stock of assets is uncertain, and it is likely that it will remain larger than it has been.

Bailey went on to provide some guidance as to how the Bank will begin the taper. When its reference rate reached 0.5%, the bank would stop reinvesting the proceeds of maturing debt as long as it makes sense for the economy.

Consideration would then be given to selling down holdings when the rate reaches 1%. In previous guidance, this figure was 1.5%, which shows that the timetable has shifted.

The pound reacted positively to the outcome of the meeting, rising versus the dollar to a high of 1.3949 and closing at 1.3929. The reaction was modest, in line with the fairly predictable outcome of the meeting and its changes in guidance.

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FOMC members falling over themselves to predict date

When is advance guidance not advance guidance? When regional Fed Presidents and FOMC members begin to all start to voice the same opinion about the direction of Fed policy.

Given what has gone on over the past week or so, it is almost as if Jerome Powell has brought everyone together and demanded that they speak with a single voice about the need for a reduction in the level of asset purchases to begin in the Autumn.

Deputy Governor Richard Clarida has been the most vocal and definite about what is likely to occur later in the year and short of Powell actually commenting, Clarida is the next most senior official.

The only comment that has shown even a minor deviation for the script has come from Christopher Waller, a relatively new member of the Fed’s Board of Governors, who has expressed the view that inflation is likely to cool off in the latter part of the year.

That was about the only comment Waller made in a recent TV interview that could be considered dovish. In the main he is bullish about the economy, and in particular employment over the next eighteen months, voicing an opinion that the 20 million jobs that were lost to the Pandemic will all be recouped.

The number of Americans applying for unemployment benefits fell by 14k over the past week. Wheel ethos shows the data continuing to improve, there has been a noticeable slowing in the rate. The total number of new claims was 385k. This just missed the target of 380k.

Today sees the release of the non-farm payrolls data for July. Market expectation is for 900k new jobs to have been created. The risk for this is to the downside, given the notion that the rate of recovery of the economy is likely to slow moderately in Q3.

The dollar remains in a fairly robust heading into the data, which also adds risk to the downside, since a weaker than expected number will see those who have built long positions begin to bail out.

The dollar index rose to a high of 92.35, closing at 92.27. A weekly close above 92.20 would be a bullish signal for technical traders.

Euro to remain under pressure as Central banks diverge

It is hard to imagine that the euro could test the 1.20 level versus the dollar even in the medium to long term, given the beginning of a divergence between monetary policy between the Federal Reserve and the European Central bank.

While both are committed to the normalization of monetary policy, the time horizon for each to act has shifted considerably over the past week.

Despite appearing to represent a minority of ECB Council members, ECB President Christine Lagarde has used all her experience to ensure that past mistakes are not repeated and her lower for longer mantra appears to have become written in stone.

While FOMC members have been clamouring to predict that the Fed will begin to taper in October, the ECB has allowed itself to be far less bullish about the Eurozone economy, with the expiry of its current support next March likely to see it replaced with another scheme.

Interest rates are likely to rise in the U.S. in about a year, while there is currently no suggestion that Eurozone interest rates will move out of negative territory in the foreseeable future.

The ECB can afford to be more pragmatic about the economy since it doesn’t have voters breathing down its neck whose main concern is being re-elected.

That having been said, Lagarde is dealing with the national psyche of several nations who have very long memories.

Following the financial crisis where the ECB was caught having cut rates to such a degree that it didn’t have sufficient ammunition to ward off recession, Central bank policy had been reasonably aligned but with the ECB determined not to repeat its mistakes, lower for longer is definitely appropriate.

Yesterday, the euro trod water, falling to a low of 1.1828, closing at 1.1835, just one pip lower than its opening level.

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.”