8 August 2022: Bank of England under threat

Bank of England under threat

Morning mid-market rates – The majors

8th August: Highlights

  • Sunak says Truss’ plans will push inflation higher
  • Jobs data pressures Fed on rates
  • Russia cutting gas supply would deepen recession significantly

GBP – Independence to be reviewed if Truss becomes PM

Conservative Party leadership confiscate Liz Truss has been fiercely critical of Bank of Englands’ Governor Andrew Bailey. She believes that Bailey and his colleagues on the Monetary Policy Committee have lacked both vision and decisiveness in their decision-making over the past nine months.

By hiking rates in twenty-five basis point increments they have exacerbated the issues by neither fighting inflation effectively nor supporting the economy.

She believes that the Bank has flouted its independence, and it may be time to consider either adding a government representative to the Committee or to even bringing it back under the control of the Treasury.

It is essential that the Central Bank and Treasury work in harmony to achieve the goals of the Government in growth and employment while achieving its target for inflation.

It seems that the two candidates have different immediate goals for the economy. Truss believes that the impending recession can be avoided if taxes are cut sufficiently to stimulate growth while Rishi Sunak feels that cutting taxes will fuel the fire of inflation, which needs to be brought under control before any further stimulus happens.

Among data releases due to be released this week will be the first cut of GDP for the second quarter. Most analysts predict that the economy contracted by around 0.2% between April and June. This means that the economy grew at just 2.8% year-on-year.

Given the comments from Andrew Bailey following last week’s MPC meeting, this will be the first of the two quarters which leads the economy into a recession which could last up to a year.

The threat to the economy posed by high and rising inflation will be made worse if employers, especially in the public sector bow to pressure to agree to pay increases which match the rise in prices.

It is almost impossible to expect the lowest paid to support the fight against inflation when they are finding it impossible to make ends meet in the household budgets.

If the economy remains in recession or is seeing very little growth while inflation remains well above target then it is to be expected that this Parliament will run its full course until early 2025. This will provide the new Prime Minister time to bring their policies to bear.

Last week, Sterling was buffeted by several changes in global risk appetite. It traded between 1.2293 and 1.2003 and closed at 1.2056 with Bailey’s warning on recession ringing in trader’s ears.

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USD – Employment market is still red-hot.

The Employment Report for July which was released on Friday did nothing to support the Federal Reserve in its fight to lower inflation.

The economy produced 528k new jobs last month which was more than double the market’s estimate, proving that it is almost impossible to predict this data.

The most recent rhetoric from Jerome Powell appeared to indicate that the FOMC may be considering slowing the rate at which it hikes rates, but it seems that job-hopping remains fashionable.

The economy is not sufficiently strong to be producing over half a million jobs in a month, so it stands to reason that the rise in job creation is simply from those who are moving to find a higher salary. As long as this merry-go-round continues, its effect will be for inflation to continue to rise.

It continues to be questioned whether the U.S. economy is in recession. Using the traditional method, the answer is simple. Since there have been two successive quarters of economic contraction, the answer is yes.

However, no two recessions are the same, so how can they be measured in the same way? Yes, the size of the economy has shrunk, but the number of company delinquencies remains low, inflation is high, and interest rates are rising. These are not the normal conditions for a recession.

Banks are not seeing any pressure on their loan portfolios; bad debts remain low and businesses are paying their bills.

It may very well be that certain sectors of the economy are not doing as well as others, and they may be seeing conditions that relate far more to a traditional recession, but that label is impossible to stick on the entire economy.

The second quarter reporting season didn’t show that companies were in recession mode, ford, for example reported a 32% in new vehicle sales, while other sectors were similarly buoyant.

This week will see the release of all important inflation data. While the year-on-year core result is expected to have risen from 5.8% in June to 6.2% in July, month on month it is expected to have fallen, although there may be some adjustment to estimates when gauged against a still very strong employment market.

The dollar index remains in something of a confused state, Traders aren’t sufficiently confident yet to take the index back to challenge its recent high, but neither are they willing to cut longs and reassess.

Last week, the index closed at 106.65 almost in the middle of its recent range.

EUR – EU facing perfect storm of negativity

There is a storm coming for the Eurozone economy, and it is getting closer by the day. The fractured state of the administration of fiscal and monetary policy means that the region is ill-equipped.

The European Central bank has very few tools with which to deal with the effects of a recession when it is combined with high and rising inflation.

Every indicator from consumer confidence, retail sales, manufacturing industrial and services output are falling.

The situation is being exacerbated by the fact that Russia is gradually starving Germany of energy and that is spreading throughout the Eurozone.

The Russian actions, which are thinly veiled as essential maintenance that has to take place in the summer given the high demand seen in winter, are designed to bring the German economy to its knees to weaken any response it is able to make to Russian actions in Ukraine and possibly beyond.

Ukrainian President Volodymyr Zelensky has labelled Russia’s actions over energy as an act of war. That may very well be true, but the consequences of any retaliation by either Germany as a member of NATO are inconceivable.

Globalisation began in the United States with American companies exporting their industrial capability overseas to cut overheads, and many nations followed suit. Now, nations that signed cooperation deals that they felt would benefit their economies and populations are starting to see the error of their ways.

In the west, consumerism has grown exponentially leading to greater and greater reliance on supply of energy and goods as well as foodstuffs. We may never know if the Russian invasion of Ukraine had a very useful by-product in its effect on the rest of Europe or if Russia was well aware of how it was able to ensure a meagre response from Brussels, Frankfurt or Paris.

Russia signed deals with Germany to supply gas at extremely low prices ostensibly to provide it with a steady stream of foreign exchange earnings.

However, the bigger picture was that it was ensuring its dominance of energy supply to the whole of Europe and therefore its compliance.

The only thing supporting the euro currently is the market’s level of uncertainty over the dollar index. While the summer lull continues, narrow ranges are expected to prevail, but once activity begins to pick up, bid may dry up and a semi-permanent residence below parity will begin.

Last week, the single currency fell to a low of 1.0122 and closed at 1.0162. Its highs continue to be lower as sell orders are placed at more aggressive levels.

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.”