9 November 2022: Economy to shrink 10%

Economy to shrink 10%

9th November: Highlights

  • Shrinking workforce a driver of higher inflation
  • Republicans confident they can shift the balance of power
  • Eurogroup meets to discuss energy support

GBP – Record rate increases are harming the economy

Latest projections indicate the impending recession may cause an economic contraction as great as 10%.

In its latest forecast, the Bank of England that the economy will shrink over the course of eight quarters beginning with the current period. The projection is based on a forecast that short-term interest rates will reach 5.25%.

The vote at last week’s MPC meeting was 7-2 in favour of a seventy-five-basis point increase. The two who voted against it were Silvana Tenreyro, who voted for a twenty-five-point hike and Swati Dhingra, who voted for fifty points.

The appointment of Dhingra has made the overall position of the Monetary Policy Committee marginally more Dovish. This was her second meeting, and she has now voted for hikes below the agreed level on both occasions.

Tenreyro, appointed in 2017, is considered a bit of a dove, having voted for small hikes at two of the past four meetings. But she appears to be more considerate about her view considering several factors when casting her vote.

After studying the voting records since Michael Saunders left, no one is as aggressively hawkish as he was. Only two votes have been cast for a hike more than what has been agreed. They came from Catherine Mann and Deputy Chairman Jonathan Haskell at the earlier meeting.

In a speech made yesterday, Huw Pill, the Bank’s Chief Economist, commented that upward pressure on inflation is being exerted by the increase in those taking early retirement. He went on to say that the MPC has not yet considered when it will taper the current programme of hikes.

Data released yesterday showed that the current rise in grocery inflation is the highest on record. In October, the index rose by 14.7% compared to a year ago. This translates into an increase of close to £700 pounds on average.

The peak of the rise in prices is not yet in sight and is estimated to be between 18% and 20%.

The Pound continues to climb away from support at the 1.12 level versus the dollar. Yesterday, it reached 1.1598 and closed at 1.1536

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USD – Former President’s stranglehold on GOP tightens

The current position of the Parties in the vote to appoint a new Senate is even at 46 votes for each Party. The magic number is fifty, and the balloting has so far gone almost exactly as predicted.

Donald Trump has featured prominently. Almost as soon as the Governor of Florida, Ron DeSantis retained his seat, which was expected to be the catalyst for a 2024 Presidential bid, Trump warned him against running, saying that it would be a mistake.

Trump is casting a large shadow over these elections, with several Republicans owing their candidacy to his support, both financially and by the provision of his army of supporters.

Questions are being asked about whether the Fed should temper its aggressive hiking of interest rates, given the effect that higher rates have on the costs of overseas borrowers of dollars and the current strength of the U.S. Dollar.

When questions are put to Fed Chairman Jerome Powell on this subject, he generally responds by saying that he is in regular contact with the heads of several Central banks, and the most effective help that the Fed can offer is to vanquish high inflation that is also affecting the global economy.

Several bank CEOs agree with these sentiments, feeling that the Fed has a job to do at home.

The stronger-than-expected October employment report appears to have pushed back any thought of a slowdown in interest rate increases. A couple of months ago, the common view was that the December hike would signal the beginning of the tempering of hikes.

Given the Fed’s oft-repeated focus on data, there is no prospect of any moderation in the size of hikes while the economy is adding more than 250K new jobs every month.

The outcome of the election will decide the short-term path for the dollar, as it will affect the ability of the Biden Administration to pass the measures they believe are necessary to avoid a recession.

The Dollar Index continues to correct. It fell yesterday to a low of 109.36 and closed at 109.62. It is sitting right on the medium-term support line, and the support will likely hold at the first attempt.

EUR – Frugal five believe that support will push inflation higher

Eurozone Finance Ministers met yesterday, and the main item on the agenda was whether the Union should consider blanket support for energy supplies.

Most of the indebted nations believe this is necessary if a deep and long-lasting recession is to be avoided, while the wealthier nations believe that such a move will fuel inflation.

They agreed to form a committee to study the issue further and report back.

There is now little doubt that the economy is facing a recession and a period of stagflation. Christine Lagarde is still in denial about whether a recession is certain. She is not likely to comment on how long it will last or how deep it will be.

For now, the most pressing issue facing the Central Bank is how to avoid inflation being ingrained in the economy as workers routinely demand wage increases in line with the rate of inflation.

An improvement in retail sales was seen in September, despite record inflation. The August figure was revised upwards from a fall of 0.3% to flat, and September saw a rise of 0.4%. While these figures are far from earth-shattering, they show the resilience that is being shown by the public in the face of high, and rising, inflation which is damaging consumer confidence.

While this is unlikely to be the watershed for continued improvement, it may at least mark the hiatus in continuing weakness.

Christine Lagarde is beginning to face criticism from several members of the Eurogroup but remains determined that an economic recovery can only begin once inflation falls close to the ECB target of 2%.

The euro is still bogged down by the market’s continuing view that it is a weak currency beset by structural issues. For this reason, they see every rally as an opportunity to sell into any rally.

However, if it can stabilise above parity, it may go some way to changing that attitude. Yesterday, it rose to a high of 1.0096 and closed at 1.0071

Have a great day!

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.