Bailey, insistent over inflation
8th July: Highlights
- Bailey remains defiant over inflation
- FOMC minutes see elevated uncertainty around economy
- Economy staging a comeback but what about the delta variant?
House prices settle as stamp duty effect fades
The resurgence of the delta variant of the Covid-19 virus could still derail the scheduled reopening of the economy on July 19th, but the effectiveness of the vaccine shows that despite infections rising, hospitalizations and fatalities remain at low levels.
The Bank of England Governor Andrew Bailey is feeling more and more pressure to act to tighten monetary policy in light of rising inflation. He remains stoic in his determination to continue to support the economy, which he considers still to be at risk.
He is basing his desire to continue with bond purchase and historically low interest rates around the fact that Government support is slowly being withdrawn and that could have a significant effect on growth.
Employers are being expected to contribute more to the furlough scheme, and that will in all likelihood lead to a rise in businesses closing their doors permanently. There has been speculation for some time that without support, many firms are simply not viable.
The change in working practices that is seeing many businesses adopt a hybrid policy for working from home versus attending the office will also have a knock-on effect on support businesses. Cafés and coffee shops are the obvious victims, but there is a whole support structure that will see its customer base permanently decimated.
The other significant withdrawal of support has been for the housing market, with the Stamp Duty holiday finishing at the end of last month.
Data released yesterday showed that the market was dampened down by the withdrawal of support, but overall, it remains well into positive territory.
The pound is struggling to find a direction in a market that is beginning to thin out as the summer lull begins. It will be a couple more weeks before liquidity starts to be affected, but for now the pound is in a familiar range.
Yesterday, it traded between 1.3841 and 1.3753, closing just one pip higher on the day at 1.3800. Versus the single currency, it is a similar story. It reached 1.1706, cloning close to that level. It has been trading sideways since a leap seen in early May, and it is uncertain what factors could emerge that would push it in either direction.
Minutes less bullish than expected
That was a significant change to recent guidance, which led the market to believe that there would be no change in interest rates before 2024.
The minutes of the meeting prodded more detail, but no more clarity over its shorter-term plans.
The Fed has for some time been more outcome focused than trajectory focused. That is to say it expects inflation to rise, given the measures in place, but is not concerned about data around that as it cannot predict absolutes.
The minutes admitted that inflation has risen more than was expected, and it was agreed that in the longer term, it would fall back into the target range around 2%.
The members agreed that while no timetable was being set for the tapering of asset purchases, it is important that the Fed be positioned to begin to reduce the level of purchases in response to unexpected economic developments, including a faster than expected progress for the recovery.
At future meetings, it was agreed that there would be discussions concerning plans for adjusting the path and composition of future purchases. More detail, less clarity!
The FOMC still believes that inflation remains transitory, but there is no way of contradicting that statement, so traders and investors gave the Central bank a free pass on that, for now.
The dollar index remains too low to sell, but too high to buy for many market participants at the moment. Here is a certain sense growing that the FOMC won’t be bullied by either inflation, which it knew would rise, or the market and will adjust monetary policy when it feels the time is right.
The index rose to a high of 92.84 and closed at 92.72.
Inflation, a spectre on the horizon
The attitude of the hawks is that the inflation target was put in place for a reason and therefore any break whatsoever, needs to be justified and dealt with. Even the fact that the economy has gone through a tumultuous upheaval not seen in generations is, it seems, no excuse.
It is also interesting to note that the target for inflation works only in one direction.
When inflation was falling below 1%, no one was concerned that it needed action taken to lift it closer to the target, but even an approach towards 2%, and it feels like the sky is falling.
Today, the ECN will release the minutes of its latest meeting. Given the rate at which the economy is reopening, and measures are being reduced, the fact that these minutes are close to a month old, renders them a little out of date.
The release of the minutes is unlikely to provide any shattering insight, and in any case the event will be overshadowed by a speech from ECB President Lagarde in which he will outline the findings of the recent strategy review.
Experience teaches us that the Central bank will only tell the market what it believes the market can cope with, and it is fairly certain that the bank won’t fundamentally change its strategy. There may be a moderate change of the language around the inflation target, but that is expected to favour the doves, by softening the emphasis a little.
Just how the discussion went around the maintenance of a significantly higher pace of bond purchases will make an interesting read, but the market is already seeing the outcome, so how the decision was arrived at may be considered superfluous.
The euro remains tethered to the dollar, and it is likely to remains so as long as it makes-up such a large proportion of the basket that makes up the index.
Yesterday, it fell to a low of 1.1781, threatening support, but closed at 1.1790.
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.”