Service activity at ten-month low
7th January: Highlights
- Service sector hit by Omicron absences
- Jobless claims are still around 200k
- German economy grinds to a halt
Employer confidence falling
Data released yesterday shows that services activity in December contracted significantly in December, falling from 58.5 to 53.6.
City centres and high streets were badly affected in December by the Government’s call for people to work from home if possible and to limit socializing.
As activity falls, inflation continues to rise. The Bank of England is expected to hike rates three times this year following its first hike in December after agreeing that inflation must be its main focus in 2022. Rates are expected to reach 1.25% before the end of the year. This is still historically low but will be their highest level since 2009.
Forecasters believe that inflation will peak in April but will reach 7%, more than three times the Central Bank’s target, before gradually falling. It is still expected to be around 4% at the end of the year.
The various increased costs of households brought about by inflation, tax increases and sky-high energy bills will drive a squeeze on the consumer, adding to pressure on growth.
There are limited actions that either the Government or Central bank can do to ease this burden. A cut in VAT on energy bills has been suggested but that will add to Government borrowing at a time when the Chancellor is still trying to recoup the support he provided since lockdowns began.
The economy is becoming more fragile as the Prime Minister continues to eschew further tightening of restrictions. The next two weeks have been described as critical, as the NHS is in danger of becoming overrun.
While it is a useful marketing tool to say that those in hospital are overwhelmingly unvaccinated, the fact is that vaccinated or not, they still require treatment.
A significant lack of investment in the years of austerity before Boris Johnson became Prime Minister is now being criticized from all sides, and Johnson’s promise of new hospitals being built across the country has not yet seen the light of day.
The pound is still finding support from a more hawkish Central Bank, but that may begin to fade over the next few months.
Yesterday, it fell to a low of 1.3490 but recovered to close at 1.3530.
Surge in imports leads to 19%+ MoM increase
After narrowing sharply in October, the record deficit of $81.4 billion seen in September stays under threat.
This is a highly volatile dataset and while the latest data is close to the record, there are several factors at play that have brought the deficit to this level.
Customs clearances and declarations have become difficult to regulate as goods leaving ports have been badly affected by logistics problems while ships remain anchored offshore awaiting berths.
While imports surged 4.6% to $304.4 billion, exports were barely changed at $224.4 billion.
The far smaller surplus in services rose in November to $18.8 billion.
Following this week’s release of the minutes of the latest FOMC meeting, a more hawkish outlook is expected to be adopted by the Federal Reserve.
Despite staying reactive, the Central Bank will be looking at overall data releases month on month to gauge how the relationship between growth and inflation is moving.
Having seen both private sector payrolls and weekly jobless claims data supply a positive view, expectations for today’s release of the December employment report are approaching unrealistic levels.
The band of expectation for the headline non-farm payrolls is between +300k and +600k new jobs being created in December. Today’s data accompanied by headline inflation numbers due next Wednesday, will set the tone for the dollar’s path until the next FOMC meeting
While there is unlikely to be any change to either rates or the pace of withdrawal of support at that meeting, there may be some hawkish comment about a reduction in the size of the bank’s balance sheet.
This should keep the dollar well-supported as its year-end correction lower ends.
Yesterday, the dollar index rose to a high of 96.38, and it closed at 96.23.
Stagflation red flags everywhere
In normal times, a rising growth leads to rising wages, together with higher prices for goods, which in turn lead to inflation. Central Banks are charged with encouraging growth and employment while keeping inflation under control.
An economic cycle evolves where the Central Bank will hike or ease interest rates to exert control over these factors.
Currently, there seems to be an either-or situation evolving, particularly in the Eurozone where it seems that either inflation can be brought back under control by the ECB withdrawing extraordinary support and hiking rates, or it can continue on its current path of encouraging growth virtually at all costs.
Going back a couple of decades when the Eurozone was still forming, the popular expression was that one size does not fit all.
What was meant by that was that a monetary policy which keeps tight control of inflation while the economy grows organically, may suit the stronger economies of Germany and other northern countries, but fiscal support in the shape of lower taxes and Government grants as seen in Spain and Italy becoming limited due to their inflationary characteristics would be harmful.
While that mantra has become somewhat ignored, it now appears to be coming to fruition.
It has taken a bold, some would say reckless, move by the Central Bank to virtually abandon control over inflation to supply support to those weaker economies.
Due to the current economic conditions being unusual to say the least, rising prices are not being matched by activity in the stronger economies and, Germany is a good example, growth and activity are dwindling while monetary policy is not keeping inflation under control.
Data, released yesterday, showed that CPI in Germany rose to 5.3% from 5.2% in November, and is now at its highest level since 1992. This coupled with PMI’s that are flirting with the 50 level means that Germany could soon see contracting output and rising or continually high inflation.
It would be ironic if after years of exerting control over the ECB despite there never having been a German President of the ECB, that twenty years after trying to prove that one size does in fact fit all, that the Pandemic saw an unravelling of the entire experiment.
Yesterday, the euro weakened against the dollar. A by-product of the ECB’s monetary policy should be a significant weakening of the currency. This, in the long term, would be a benefit since it will encourage exports while limiting imports, although the much-vaunted single market has still to show its strength.
The euro fell to a low of 1.1284 and closed at 1.1291.
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.”