8 August 2023: Victory is far from being declared according to Bailey

8 August 2023: Victory is far from being declared according to Bailey


  • Business confidence fall is accelerating
  • Resilient economy will need multiple rate hikes
  • Investor environment has nosedived so far this month
GBP – Market Commentary

Inflation is still too high, but monetary tightening is working according to Pill

Andrew Bailey, the Governor of the Bank of England believes that there is still more work to be done before victory can be declared in the fight to lower inflation.

Although the pace of price increases has slowed in recent months, the country is still subject to “global shocks,” such as the Russian withdrawal from a pact to allow free access to grant carrying vessels using Black Sea ports.

For this reason, it remains impossible to be exact in estimates about when interest rate increases will be halted.

Bailey’s colleague and fellow MPC member, Huw Pill, the Bank’s Chief Economist, spoke yesterday of his own view that rate hikes have begun to have a significant effect on inflation as they reach a neutral level where they are neither expansive nor restrictive on demand.

Although the two most significant contributors to the rise in the cost of living over the past year or so are matters that the Bank has no control over; the rise in energy, and basic foodstuffs, the knock-on effect of these means that demand needs to be tempered by tighter monetary policy.

Higher levels of employment are also a factor in bringing down headline inflation as there are fewer job vacancies, although the number of candidates has remained constant.

With hindsight, as well as the external price shock that have occurred, Brexit and the departure of migrant workers from EU member states also has been a contributor to the rise in inflation.

Pill went on to say that the MPC has become even more data-dependent over the past quarter or so, which is evidenced by the variation in the size of the rate increase agreed at the June meeting.

There is no pre-ordained path for interest rates since the Committee is driven by the economy and the monthly data.

For this reason, none of the committees can provide a firm answer to the questions about when the chain of rate hikes will be broken or when the Bank will be able to start to bring rates back down.

The previous cycle which saw rate fall to historical lows lasted far longer than normal, but there is no reason to believe the cycle of rate hikes, or rates staging at these elevated levels, will last as long.

The pound remains stable at the moment due in no small part to the slack of activity in the market currently. It rose to a high of 1.2789 yesterday and closed at 1.2784.

USD – Market Commentary

First signs of public dissent from the FOMC

The President of the New York Fed, John Williams, was the first regional Fed President to comment on the FOMC’s decision to resume its cycle of rate hikes at its most recent meeting.

He voted for the increase, although there were “several” of his colleagues who felt that another pause was warranted.

He went on to say that in the medium term, since rates have now, in his opinion, reached a restrictive level that, as inflation falls further, the Fed will feel more comfortable in deciding that rates should level off and then fall.

Williams, in an interview with the New York Times late last week, spoke of his view that the economy is going through an almost unprecedented time of evolution which only happens once or twice in a generation.

The technological advances that are being seen in AI, in particular, mean that several jobs within the economy will disappear in the coming decade(s), and preparation for that eventuality should be taking place now.

That preparation is less glamorous than the breakthroughs that are happening elsewhere, but that does not make it any less essential.

It has been shown that despite the significant increases that have taken place in interest rates over the past fifteen months, not only has inflation continues to rise, although thankfully it is now on a downward trajectory, but job growth has been exceptional, which has led to a feeling of resilience in the economy.

Williams does not believe that the economy is heading for a recession, although there is some continued concern over the inversion of the yield curve, which is a significant indicator of the markets’ concern over issues that may arise in the coming year or so.

The FOMC can only deal with what it sees right now as far as economic data is concerned, and at the present time, the economic developments are broadly in line with what was expected.

The employment market is cooling, although not as quickly as has been seen during past tightening cycles, but that is also a factor in the evolution of the economy.

Williams is also prepared to be data-driven and makes no prediction about when the cycle will end.

While his comments chime with those of his FOMC colleague Michelle Bowman, he appears to be less hawkish about further increases than the Fed Governor, who believes that rates will need to rise further as she looks for evidence that inflation is on a consistent downward path.

It is unusual to find such opposing views of the economy from FOMC members, and this is an indication of the level that rates are now at. Bowman clearly believes monetary policy is at a neutral level, while Williams believes that they are now restrictive.

The dollar index initially attempted to recoup its losses from Friday as it rose to a high of 102.38 yesterday, but the rally quickly ran out of steam, and the index fell back to close at 102.07.

EUR – Market Commentary

Headline inflation will see a dramatic fall later in the year according to Philip Lane

As headline inflation has fallen over the past few months, ECB officials have been more concerned about the core which has remained uncomfortably high.

News released yesterday showed that core inflation is now also falling primarily due to more moderate wage settlements that have been agreed.

The Chief Economist of the ECB, Philip Lane, is confident that both the headline rate of inflation and the core will fall significantly since interest rates have now most definitely become restrictive on demand.

Lane believes that headline inflation peaked some months ago, but the continued rate increases have been necessary due to the nature of the fiscal nature of the Eurozone.

Lane also believes that the root cause of inflation has been external factors as well as the level of fiscal support that was delivered by various Eurozone members during and immediately after the Pandemic.

Although inflation mostly peaked earlier in the year, it remains high overall, Lane believes, although that comment betrays a certain level of conservatism about economic developments that are taking place within several member states.

Germany will struggle to see any growth this year, as will Italy, but they both see the challenge differently.

Germany’s Bundesbank is committed to lowering inflation by ever tighter monetary policy, and this has the full support of both the Government and voters, who see rising prices as the most crucial factor in the country’s current issues.

Italy, meanwhile, puts the blame for its fall into a recession squarely at the door of the ECB and its rush to hike rates which, in their view, has been unnecessary. There have been several alternatives put forward by Central Bankers and Government officials in recent months, although the Italian with the most experience in the workings of the ECB, Mario Draghi, has been strangely quiet since he stepped down as Prime Minister.

Christine Lagarde has come in for severe criticism for being too hawkish in voicing her views on monetary policy which has alienated the more hawkish faction within the Governing Council. Those criticisms are likely to come to the fore once the August break is over and the discussion about another hike at September’s meeting is discussed in earnest.

Lagarde is already lacking support from Italy, Spain, and Portugal, although the Heads of the Central Banks of Greece, Cyprus and Croatia have been broadly supportive.

The Central Bank of her home nation, France, has been more moderate, both supporting rate hikes but recently putting forward a proposal to cease further hikes and commit to rates being held at their current level for longer.

The euro remains in a broad 1.1050/1.0950 range as factors affecting it dry up. It rose to a high of 1.1018 yesterday and closed at 1.1002.

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.