8 September 2023: Businesses see inflation falling rapidly

When the comments made by Andrew Bailey and Swati Dhingra in their joint testimony before the Parliamentary Treasury Select committee are considered, it would now be a major surprise if the Monetary Policy Committee went ahead and hiked rates again at their meeting on 21st September.

In a further boost to those hoping for a pause, small and medium business owners feel that inflation is beginning to fall more rapidly.

This expectation is based upon the cost of raw materials and imports of finished goods at the factory gate.

Bailey’s comments made perfect sense to the market. It would have been foolhardy for him to say that the end of the cycle of rate hikes is close.

But to hint at a pause that will leave the door open for another one or two hikes later in the year, should the need arise will have encouraged the market that after a rocky few months, where not only the decision-making process has been questioned, but the entire makeup of the Committee and the rationale for its existence.

Since Gordon Brown made the decision to make the Bank of England independent of Government, the successive Governors have had a reasonably comfortable ride in deciding monetary policy.

That is not to say that their job has been simple. There have been numerous regulatory challenges and of course Brexit created a unique set of problems of its own.

It was thought that GDP had remained below pre-Pandemic levels until quite recently, making the UK the last member of the G7 to return to “full health. A recent study by the Office for National Statistics found that in fact it reached its pre-Pandemic level in Q4 2021.

GDP grew on a par with France and more strongly than Germany, although that has been a matter for celebration that has been mostly limited to the right-wing press which has championed Brexit from its inception.

The Prime Minister is under pressure to axe approximately 90,000 jobs from the Civil Service to avoid a pension’s disaster. The number of retired Civil Servants receiving pensions more than £100k per year has doubled, with their inflation linked benefits likely to see another seven per cent leap next year.

Sterling has suffered from the market’s new-found expectation of a pause in interest rates hikes from this month.

Yesterday, it fell to a low of 1.2445 and closed at 1.2472. Versus the Euro, it fared little better, it fell to a low of 1.1625 but recovered most of the lost ground to close virtually unchanged at 1.1659.

Both Sterling and the Common Currency are suffering from the expectation that their respective Central Banks will pause rate hikes this month. While this is also true of the Federal Reserve, the U.S. economy is in a far stronger position from either the UK or Eurozone.

One of the major surprises of the Federal Reserve’s lengthy programme of interest rates increases is the negligible effect it has had on the employment market.

That new job creation is still well into positive numbers, despite the Central Bank raising rates at eleven consecutive meetings from March 2022. Five hundred basis points of increases have not had the effect on the employment market that was predicted in the Autumn and Winter of last year.

In fact, the most notable effect of the rate hikes has been on the housing market and its ancillary sectors.

Home sales, of both new and existing properties as well as building permits and building starts have suffered far more than the employment market.

The reasons for this are unclear but have something to do with not just the rapid increase in home loan rates, but the fact that they were at historic lows when the Fed began its cycle of rate hikes.

Stronger than expected figures for services output last month have increased the chances that the country will see the fabled soft landing achieved.

Services output was at 54.5, well into expansive territory and its highest in six months.

The pickup was broad based, across several sectors and regions of the economy. This may encourage a more widely spread view of the economy from amongst FOMC members, several of whom represent Regional Federal Reserves.

There is a feeling in the market that the dollar is on the cusp of its longest rally in years in terms of both time and gains for the index.

The U.S. has not been significantly affected by the war in Ukraine, while the Eurozone economy is still suffering and will for the near future.

The 110 level looks to be within relatively easy reach and the correction that began in March, and reached its nadir in July is now well and truly over.

Yesterday, the dollar index reached a high of 105.15 and closed at 105.06. It may falter should the FOMC vote to pause rate hikes, particularly if the ECB votes to continue, but any fall should be short-lived.

There is a genuine sense of drama building in the market as the next ECB rate-setting meeting approaches and the members of the Governing Council enter a week-long period of new blackout.

While Austria, Latvia and Slovenia will vote for at least one further hike, it is also evident that Italy, Spain, Portugal, and Greece will vote for a pause.

The German Central Bank President, Joachim Nagel has been reluctant to discuss a tightening of monetary policy recently obviously finding it difficult to promote higher rates when his country’s economy is in such a parlous state and likely to be in recession in all but name.

Even if he is showing a slightly dovish side in public, Nagel will probably vote for a hike, but be secretly pleased if he is voted down.

Unlike the FOMC and MPC, the votes of the Governing Council are not made public. There are several other Central Banks where the votes are made public, and there is a discussion about whether that should happen at the ECB too.

For this month’s meeting, more than any other, the members of the Governing Council will feel relieved not to feel the need to justify the vote.

In the past, the Banque de France’s Governor, Francois Villeroy de Galhau would have been pleased not to have to explain how he voted given his previously hawkish views, but latterly he has joined the ranks of the doves, a stance far more in keeping with his country’s economic position.

Along with Villeroy de Galhau, ECB President Christine Lagarde has also reined in her more hawkish tendencies of late. It is unclear whether she is taking a more holistic view of the Eurozone as a whole or if she is simply “keeping her powder dry.”

Many economists will hope for the former but expect the latter.

It may be that the Euro has already begun its “long march towards polarity and below, especially when considering the bullish sentiment flowing through Wall Street and beyond.

Yesterday, the single currency fell to a low of 1.0686 and closed at 1.0696. This was its first close below 1.07 since May 31st.

Have a great day!