6 February 2023: Jury out on size of recession


  • Truss continues her delusion
  • Jobs data ensures further hikes
  • Energy support to continue
GBP – Market Commentary

Any new public sector pay deals will keep inflation high

There is still no definitive answer to the questions about the length and depth of the recession, which the UK is probably already seeing. There is no question that the economy is slowing, but there are too many imponderables to be able to say that the country will be in recession at the end of 2023 or how bad the telltale signs of a recession will be.

Unemployment remains at a historic low, and although business liquidations are beginning to rise, they are still not rising to a level which raises significant concerns.

The property market is one of the more obvious areas where the continuous interest rates rises that have taken place over the last year or so are beginning to see and effect. House prices are 3.2% lower than they were last August and high street bank, Santander, believes that they will fall by 10% this year.

Despite the gloom, the mortgage lenders are returning to market with a wider rate of products offering protection against higher rates.

The single most important reason for the disarray that enveloped the mortgage market in 2022 was Liz Truss, who almost completely destroyed confidence with a misguided policy of cutting taxes and funding them with significantly higher borrowing.

Ms Truss is attempting a comeback, evidenced by her appearance on the weekend political shows explaining that she was misunderstood and the victims of the left wing establishment. This appears to be a figment of her imagination.

In fact, her defeat of Rishi Sunak in the leadership election was the last telltale sign of just how old-fashioned the membership of the Conservative Party had become and at some point when he has dealt with the issues he is facing, the Prime Minister is going to have to tackle the modernization of his Party.

There have been a barrage of responses to her remarks from senior Conservative members of Parliament, commenting that she was and remains deluded to the need to carry their support to gain their confidence in such a radical agenda.

The Bank of England raised interest rates for the tenth consecutive meeting last week. The fifty basis point hike brought the base lending rate to 4%, but inflation is not falling significantly, which is a tell-tale sign that rates will need to continue to rise to bring down demand.

The pound fell last week versus the dollar as the FOMC also raised interest rates, although neither Central Bank made a convincing case for further significant hikes, while the ECB is now considered the most hawkish Central Bank of the G7 nations.

Sterling’s fall was also in reaction to significantly stronger data published by the U.S. It fell to a low of 1.2050 and closed on the low.

MPC member Catherine Mann and BoE Chief Economist, Huw Pill, will both make speeches this week. Mann remains hawkish on Interest rates and will likely speculate of further hikes, while Pill will likely give the Bank’s view on the economy.

Q4 GDP data is due for release this week. It is unlikely to be positive after a fall of 0.3% in Q3, but the economy may have contracted at a marginally slower rate.

USD – Market Commentary

Unemployment falls again, but wage growth slows

One of the most significant takeaways from the January employment report, which was published on Friday, was the futility of making any sort of prediction about the number of new jobs created.

At the start of the fourth quarter of 2022, several eminent economists forecast that the U.S. economy was deteriorating at such a rate that they believed that the January NFP could easily be negative.

In fact, the economy delivered 517k new jobs in January. This was more than double the revised number for December. There may well have been some technical reason for the rise, but there is no doubt that when it comes to jobs, the economy is relatively healthy. The unemployment rate fell to 3.4% from 3.5%, although the rise in hourly earnings fell to 0.3% from an upwardly revised 0.4% in December.

The FOMC tapered the size of its recent rate increases at its latest meeting, which concluded last meeting. The press conference which followed the meeting was a difficult experience for Fed Chairman Jerome Powell.

He had to deliver the views of the majority of his colleagues, while apparently disagreeing with the conclusions which led to a hike of just twenty-five basis points.

Powell was firm in his view that it is too early to declare victory in the battle against rising inflation. The market accepted his view, although the dollar did fall in the wake of last week’s Central Bank meetings.

However, the index rallied strongly in the wake of the employment report. It reached a high of 103.00 given the inflationary effect of an economy which is able to create a significant number of new jobs at this stage in the cycle.

This week, there is very little tier one data due for release. Jerome Powell will make a speech tomorrow and his FOMC colleague, John Williams, President will speak on Wednesday. Williams spoke recently of his expectation that inflation would fall to an average of 3% this year, so the market will be paying attention to his comments regarding the employment report.

EUR – Market Commentary

ECB has some distance still to travel

The most significant takeaway from the latest meeting of the Governing Council of the ECB, which took place last week, is that this Central bank still has a long way to travel before interest rates become restrictive.

The result of the meeting was, yet, again a compromise which at the end of the day suited neither the hawks nor the doves but was sufficient not to drive open conflict between the members.

A fifty point was virtually baked in, and a similar hike is daily certain for the next meeting, which will take place in the middle of March.

There was not a great deal of clarity in Christine Lagarde’s press conference. She acknowledged that interest rate hikes are not without their own risks, but the risk to the Eurozone economy of rising inflation is far greater.

Italy, which has railed against the policy of continued rate hikes, moderated its ire this time. The Head of the Italian Central bank commented that the current rate of increases is broadly manageable for Italian public finances. While this is the public view of the Banca D’Italia, in private it is likely that there were strong views on show.

Last week, before the meeting took place, Lagarde asked Eurozone members to consider dialling back their support for energy bills. This she believes is contributing to inflation and slowing its fall. Her request received only lukewarm support.

The euro initially rallied against both the dollar and pound following the rate setting meeting, but fell significantly in the wake of the U.S. employment report. It reached a weekly low of 1.0793, having briefly breached the 1.10 level earlier.

This week, retail sales data will be released. Although sales will still be negative YoY, the rate of fall is expected to have lessened. Data for German industrial Production is also due for release.

While its economy is showing signs of recover from its own downturn, industry remains in the doldrums due to fears of any change in the gas price and an expected escalation of the conflict in Ukraine.

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.