UK could be a loser in Global taxation regime

Andrew Haldane, the Bank of England’s Chief Economist, for whom the next MPC meeting will be his last, spoke yesterday of his belief that any overheating in the economy will manifest itself in the property market first.

He described the market as being on fire, due mainly to the disparity between supply and demand.

The Government’s support for the economy has led people to see an opportunity although this effect will fade as quickly as it has started as Chancellor Rishi Sunak has already announced the end of several support schemes.

The short-term continuation of tax breaks, the growth in the savings rate and the increasing equity as prices rise are driving the market which saw a 10% rise in average prices in the 12 months to March.

While this activity is positive for the recovery it can lead to widening of the gap between the well-off and young first-time buyers who will find raising a deposit that much more difficult in years to come.

Representatives of middle-income groups have also criticised the Chancellor for pushing up the price of available properties out of their reach even with several incentives.

Mortgage lender’s surveys saw monthly increases of 1.3% in May as the rises seen so far are set to continue even after the benefits are withdrawn.

Over £160 billion in savings has built up over the lockdown and this is fuelling economic activity and price growth as it begins to flow back into the economy.

Haldane’s colleagues Deputy Governor David Ramsden and Head of Oversight Sir Jon Cunliffe have both spoken about the property market recently.

Cunliffe spoke of his fear that lenders are not acting in the most judicious manner when making mortgage offers, while Ramsden commented that the Bank is monitoring the situation closely due to its effect on overall price inflation across the economy.

The FX market has relapsed into its wait and see posture as Central Banks ponder rising inflation and the timing of any move to tighten monetary policy.

The pound fell to a low of 1.4121 but recovered to close at 1.4155.

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Roaring back from the brink will bring temporary inflation

The U.S. economy has been described as roaring back from the brink recently as the stimulus that has been poured into it drives the gap between supply and demand wider.

Fears are emerging that the economy can suffer from too much of a good thing, and that is driving issues that were unforeseen when the stimulus packages were first envisaged.

It is difficult to equate just how much is too much when it comes to stimulus. This is a wholly new phenomenon for the U.S. where social benefits have been traditionally low and hard to come by.

Now workers who would have been struggling to find employment as the country emerges from a recession are faced with choices they have never had.

This has manifested itself initially in increasing levels of vacancies.

The most recent data shows that job openings surged to 9.3 million in April. This was an increase of over 12% from the March data. Over the same period, hirings were up by just 1%. This suggests that vacancies are opening up faster than companies can fill them.

Workers resigning and looking for new positions rose by 11% in April the highest since 2000. This shows a newfound confidence driven by a most un-American feeling of comfort propelled by Government support.

The Federal Reserve has already signalled that it won’t be starting to taper its bond purchase any time soon. This signal has probably driven the FX market into its summer lull a month earlier than normal. The ECB is likely to do the same.

Central Banks are beginning to see different challenges as their economies recover and diverge but are using the same tools to combat rising inflation and the growing gap in demand versus supply.

While it is likely that the Fed will move first, Jerome Powell is far more relaxed about inflationary pressures that he continues to describe as transitory, than Christine Lagarde, who has a group of more hawkish Bankers lining up to demand action.

This summer is unlikely to see any shift in policy although the wording of the rhetoric may begin to change.

Yesterday, the dollar index rose to a high of 90.17 and closed at 90.12. While the FOMC sits on its hands, support at 89.50 and resistance and 90.60 are unlikely to be challenged.

Consistent above target inflation only driver for ECB

The difficult period the Eurozone economy had entered immediately before the Pandemic hit will have an effect on the pace of its recovery pushing it back by several quarters.

The market that has been starved of juicy titbits of usable information for, what in its terms appear to be an eternity, will pore over any change in the wording of Christine Lagarde’s comments following the Bank’s interest rate decision at tomorrow’s Governing Council Meeting.

One of the issues that is emerging is the ECB’s forward forecast for inflation.

The recovery is likely to be more drawn out due to the recession and the fact that support rather than stimulus has been the ECB’s watchword means that rising inflation will happen more slowly and be more likely to hang around.

There is a growing difference in the manner in which the world’s two largest Central Banks are going to act to deal with Inflation.

The Fed will be reactive while the ECB is forced into proactivity. It would be unheard of that the ECB could be allowed by the Bundesbank to permit inflation to rise without taking any pre-emptive course of action.

This compares to the FOMC which is prepared to deal with rising inflation after the fact.

Of course, the two may both act fairly closely together but that cannot be seen as a joint or concerted action since the recoveries are happening at a vastly different rate.

Christine Lagarde speaks of only tightening policy when inflation is constantly close to the ECB’s 2% target, but she may be outvoted by those who believe the inevitability of the rise means it should be snuffed out before it can get out of control.

That is why the ECB advance forecast for inflation in 2023 is so important to the market. They are looking for what will trigger a tightening and it is unlikely that Ms Lagarde will be allowed to adopt Powell’s wait and see policy.

The euro cannot break free of the gravitational pull of the dollar. Yesterday, it fell to a low of 1.2163, closing at 1.2174.