9 August 2021: Did Sunak Overstep?

Did Sunak Overstep?

9th August: Highlights

  • Q2 GDP to be close to 5%?
  • Infrastructure bill unlikely to see immediate results
  • Weaker euro brings inflation fear

Chancellor under threat of demotion

Chancellor of the Exchequer Rishi Sunak appears to have overstepped his authority, or at least misjudged the depth of his relationship with the Prime Minister.

He seems to have written to Boris Johnson to call for a significant easing of travel restrictions in order to speed the recovery of the economy from Coronavirus. Johnson appears to have taken the letter as both a demand that he should act and a threat that he is undoing Sunak’s work in saving the economy.

According to several weekend newspapers, Johnson was apoplectic with rage even suggesting that it might be time for Sunak to be moved from the powerful Treasury to a lesser role in health, which after recent events has become something of a poison chalice.

While this may be an insight into the personal relationships that exist (or possibly don’t) between Cabinet Ministers, it is unlikely that it will mean anything in the long run and is synonymous with the summer silly season, when reporters have little else to do other than make mischief.

BoE Deputy Governor Ben Broadbent, one of the more hawkish members of the MPC, spoke later last week of concern about the secondary effect of inflation on wages.

It is a considerable time since wage negotiations were centred around the cost of living. Inflation has been benign for some time, but any sign that its current level is anything other than transitory will see unions begin to look for settlements that consider future expectations for rising prices.

Broadbent believes that inflation could reach 4% around the end of Q4, and this may require some moderate tightening to be brought under control.

The slightly more hawkish outcome of the MPC meeting held last week, when renowned hawk Michael Saunders voted for a reduction in asset purchases together with Broadbent’s inflation concerns, failed to light a fire under Sterling.

While it remained on the front foot versus the euro, ending the week at 1.1796, It was mixed versus a stronger dollar, closing the week at 1.3874.

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Jobs data just about confirms October taper

The July jobs data satisfied the more optimistic analysts’ predictions when it was released on Friday. 943k new jobs were added, while the June figure was revised up from 850k to 938k.

It will have disappointed some observers that following such a significant upwards revision, the July number was unable to break the one million mark.

More details have been emerging about the plans that the President has for infrastructure development. Several cities will benefit significantly while transport systems, especially road transport, will be streamlined.

The view is that with nothing likely to start until later next year, this is not a bill that will help the economy to recover from the pandemic but will be representative of both what a Democratic Administration traditionally looks like, and what Biden would have started much easier if he hadn’t had major distractions to concentrate upon.

Overall, the plan is expected to add 0.2% to GDP in 2022 and 0.3% in 2023.

Not only was the headline non-farm payroll data encouraging, but there was a major fall in the unemployment rate. It fell from 5.9% in June to 5.4% in July.

Friday’s data has most likely set the seal on a tapering of the Fed’s bond purchasing programme as early as October. The hawkish speeches made by members of the FOMC were likely brought about by their sight of an advance copy of the data.

One major Democrat Senator, Joe Manchin, who wields significant power on the Finance Committee, has written an unequivocal letter to Fed Chairman Jerome Powell expressing his concerns about the economy overheating.

Manchin is concerned about rising inflation and the issues that may bring to the workforce in the form of what he called an inflation tax that they wouldn’t be able to afford.

House prices have risen by about 17% nationally, while a shortage of transport has seen shipping costs skyrocket in some areas by up to 500%.

The dollar reacted well to the employment report. It rallied to close just below significant resistance at 92.77.

Weidmann happy to bankrupt EU members?

While shipping costs are soaring in the U.S. it is a similar story across the Eurozone.

While CPI is still relatively controlled although ECB President Christine Lagarde has new powers to allow it to break the 2% barrier, concerns are rising about the significant increase that is being seen in input prices and how that will feed through to the consumer.

Given the Rhetoric that has emerged from the ECB recently, there is no doubt that a headline inflation rate of 2.5% or even 23% could be seen in the Autumn.

One of the structural issues that face the Eurozone is that every country has a different fiscal structure, and this means that their economies react to rising inflation differently.

Jens Weidmann again called for a tightening of monetary policy in an article published over the weekend. His hawkishness actually extended to saying that curbing inflation is more important than holding down financing costs.

That is tantamount to saying a theoretical issue that may arise is far more important than making sure Eurozone members are able to finance their debts that have come about in the short term through no fault of their own.

There will be several Heads of Government and Central Bankers celebrating the day that Angela Merkel decided to support von der Leyen for the EU president’s job and ditched Weidmann’s candidacy for the ECB role.

If it is accepted that inflation is going to rise in the Eurozone, and it may indeed be transitory, a further consideration will be the level of the single currency.

While it is well known that a weaker currency can help with exports, it also imports inflation. With the monetary policy of the UK and U.S. on one side likely to be tightened while policy in the Eurozone remains loose, it is easy to see a significant drop in the value of the euro over the second half of this year and well into 2022.

Last week, the euro fell versus a stronger dollar. It reached 1.1754, closing at 1.1762.

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.”