7 June 2023: Is the 2% target now unreachable?


  • Sunak wants big tax cut to woo voters
  • Economy is in a rut despite jobs data
  • Weak data won’t deter the ECB
GBP – Market Commentary

Bank of England in danger of chasing an “impossible dream”?

The Government’s 2% target for headline inflation is looking increasingly impossible to reach.

Given the lack of growth expected over the balance of 2023, many analysts and commentators believe that if the Bank of England is unable to drive it lower in the current environment, then as growth begins to pick up interest rates would need to be raised significantly further, and even then making the UK a “low inflation economy” is neither in the Bank’s nor the Government’s best interests.

Rishi Sunak has apparently floated the idea of “considerable” tax cuts to drive the economy forward despite them being seen as little more than a sop to win votes in the upcoming General Election.

The inflationary effect of such a tactic would push any thought of achieving the 2% target even further away.

The country is falling further and further behind its G7 partners over an entire range of public services so supplying less money by way of tax receipts to bolster the NHS, the courts and public transport, among others, will threaten their complete collapse.

Pledges to supply further funding for a whole range of health-related projects including several new hospitals, employing more police and bringing the country’s transport network into the 21st century will be sacrificed on the altar of winning the election.

Were Labour to win late next year or early 2025, it is unlikely that taxes would fall since Labour is already committed to improving public services. Taxes would have to rise for medium to high earners, despite their claim that their plans are fully funded.

It may be time for the Bank of England and Chancellor to “come clean” and consider what is a sensible target for inflation while they still have reasons to abandon the current target without drawing accusations of “moving the goalposts”.

The world has clearly moved on since the Pandemic and with interest rates being raised to levels that haven’t been seen in well over a decade, abandoning the 2% target, or at least raising it to a more achievable level would allow the Bank to end its chase of an impossible goal.

Andrew Bailey, the Governor of the Bank of England will oversee a further rise in interest rates in two weeks’ time, and it is now reaching the point where the positive effect of rate hikes is becoming negligible while causing harm to those trying, or already struggling to buy their own homes, which after all, is a Conservative Party policy goal.

A target for inflation which considers global as well as domestic issues, especially given the overall effect of the Pandemic and Brexit would allow the country to move forward without unduly releasing the shackles.

Sterling is currently unable to break the 1.25 level versus the dollar conclusively. Yet again this week, having threatened to move higher it has run into strong resistance and run out of steam. Yesterday, it fell to a low of 1.2391 and closed at 1.2424.

Having broken above strong resistance at 1.1520 versus the Euro, it is in a consolidation phase while the single currency is supported by tighter monetary policy but threatened by poor economic data. It closed yesterday at 1.1619.

USD – Market Commentary

Continued rate hikes may be the “nuclear option”, but what’s the alternative?

Jerome Powell is still being pilloried for his glib, off-the-cuff remark, made close to eighteen months ago that rising inflation is transitory and will settle down as the global economy adjusts to the end of the Pandemic.

While suffering from the legacy of being appointed by former President Trump and being a lifelong Republican voter, every move he makes, and every comment he utters is seen through those twin lenses.

Since that “faux pas” he has been trying to make amends, but he is only one voice among many on the FOMC, while every member of the rate-setting committee is a potential Fed Chairman in his or her own right.

It has not been an easy twelve months to be a Central Bank in the United States.

The Federal Reserve of California faced severe criticism over its standards of oversight which, according to some, led to the collapse of Silicon Valley Bank, which threatened to bring contagion, and led to two further institutions being forced to close their doors.

All the while interest rates have been rising and now stand at something of a crossroads.

Having warned of the dangers of “painting themselves into a corner” by providing a possibly unwise level of advance guidance, Powell and his colleagues appear to have done just that, by almost pre-empting the May employment report.

Several members have voiced their support for a pause in rate hikes, yet tried to show their continued commitment to tighter monetary policy by denying that a pause will mean anything but that. The truth is that having paused, it will be extremely tough to subsequently return to the rate hike cycle, without facing further (justified) criticism.

At the next FOMC meeting, being held next week and will also see the Central Bank’s economic projections forecasts published, the result of the vote will be as important as the comments made later by the Chairman.

There will then be an interminable three-week wait for the publication of the minutes.

The dollar index is currently being supported by the seeming proactivity of the Fed which contrasts with the apparent “hell for leather” approach to interest rate hikes being adopted by the ECB. Yesterday the index was 104.40 and closed at 104.00 It continues to make successive higher closes as more investors gain comfort from being long dollars.

EUR – Market Commentary

What else does the ECB have left to offer?

Klaas Knot the Governor of the Dutch Central Bank is likely to be considered as an alternative candidate to Christine Lagarde when the time comes for her to eventually move from finance into politics.

Knott is a “card-carrying member” of the frugal five but is far from being a hawk for the sake of it.

His approach to tighter monetary policy is far more considered than that of his Austrian counterpart, while the President of the Bundesbank, who is widely considered to be the “next cab of the rank” in terms of the top job at the ECB has both significant domestic issues to deal with currently and is possibly considered to new into the role to be considered.

The ECB has a history of appointing compromise candidates which goes all the way back to its first President, Wim Duisenberg all the way to the current one.

Christine Lagarde has a far more political and diplomatic background but was “shoehorned” into the role as Angela Merkel wanted to promote the cause of Ursula von der Leyen as President of the European Commission and while Jens Weidman, the then President of the Bundesbank was considered a “shoo-in” to replace Mario Draghi, the concentration of power in German hands was considered too great.

Knot meanwhile has been a supporter of tighter monetary policy, wanting to continue fifty basis point hikes for longer than they eventually lasted, but putting forward salient and well-considered reasons for his views.

Yesterday, he spoke of the “secondary effects” of last year’s extraordinary rise in energy prices which were a direct result of the Russian invasion of Ukraine.

Although the price of energy has fallen back, the cost of oil and gas has “infiltrated” all aspects of life from food to clothing and seen both consumer confidence and retail sales fall dramatically.

Knott apparently disagrees with the Chief Economist of the ECB, since he also voiced concerns about rising wages, particularly in the service sector, which, he feels, will see inflation remain higher for longer.

The outcome of next week’s Meeting of the Governing Council is as close to a foregone conclusion as it could be. The only potential surprise would be if they hiked by fifty, rather than twenty-five basis points, although that is considered extremely unlikely.

The common currency is still supported by the prospect of higher interest rates, despite some weaker output data that has been released recently.

Yesterday, it fell back a little, reaching 1.0667 and closing at 1.0692.

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.