9 September 2022: Energy fixed at £2.5k for two years

GBP – Truss completes first task

The new Prime Minister remained true to her word and introduced a support plan for domestic consumers. The plan means that no one will pay more than £2,500 a year for their energy for the next two years.

The plan, which will cost between ninety and a hundred billion pound to implement, is expected to add to pressure for higher interest rates.

The new Chancellor of the Exchequer, Kwasi Kwarteng signalled a change to the relationship the Government has with the Bank of England.

Governor Andrew Bailey had expressed his concern recently about the continuing independence of the Central Bank. Although that independence will be supported, there will be greater oversight from the Treasury.

The Chancellor and Governor will meet twice a week to ensure that they still are on the same page and there is more coordination between monetary and fiscal policy.

Liz Truss completed the formation of her new-look Cabinet, creating the most diverse group of ministers in history. There was no job for the former Chancellor and her rival for the leadership, Rishi Sunak, although it is not clear whether he had already told Truss that he wanted to return to the back benches.

Kwarteng met with a delegation of senior figures from the City of London yesterday, including the CEOs of J.P. Morgan, Goldman Sachs and Blackrock. Also invited were senior executives from the major UK banks.

He set out the new Government’s agenda, which he told the assembled group would be unashamedly pro-growth, particularly in the areas of taxation and red tape. He also eased the fears of the Governor over the independence of the Central Bank, commenting that the Bank of England’s role in tackling inflation was critical to keeping the cost of living under control.

Kwarteng acknowledged and agreed with Bailey’s comments to the Treasury Select Committee earlier that the primary reasons for the country being on the brink of recession are external factors over which the Bank has little or no control.

Following the meeting, Goldman Sachs sent out a note to its clients in which it commented that the Government confirmed the independence of the Bank of England. It did, however, also say that it expects the mandate of the Central Bank to be reviewed this autumn, and that some personnel changes could be expected.

Sterling lost a little ground, but stayed within the range it has been in all week. It fell to a low of 1.1460 and closed at 1.1504.

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USD – Fed Chair – FOMC won’t be easing prematurely

In a speech delivered yesterday, the Fed Chairman reaffirmed that the Central Bank remains committed to tighter monetary policy, confirming that it will continue to raise interest rates until inflation has returned to the Fed’s target.

He stopped short of agreeing on what he considered to be the upper limit for interest rates but agreed that a period when rates are restrictive would be necessary. This seemed to confirm what Loretta Mester said the previous day that it would be unlikely that rates would fall before the end of 2023.

In a report on the economy released yesterday, the Fed acknowledged that demand was beginning to suffer as soaring prices meant that consumers must concentrate on providing the basics and goods which are considered luxuries have had to take a back seat.

In its beige book, detailing several statistics about the economy, the Fed commented that recession fears are still widespread, and there is evidence to suggest that wage and price pressure are beginning to ease.

The outlook for the economy is still a concern, and there are signs that demand will continue to soften over a six-to-twelve-month horizon.

Several regions are seeing a slowdown in the real estate market, which is a generally accepted forerunner of a weakening economy.

In reaffirming his commitment to lowering inflation, Powell commented that the longer that inflation remains elevated, the more the public will accept that as being the norm.

The Fed needs to be sure that the prices/wages spiral doesn’t become embedded in the wider economy. So far, there are signs that the pace of wage growth is slowing and that needs to continue.

He went on to say that the skewing of the balance between supply and demand needs a further adjustment, and the Fed expects that to be addressed by a period of tight and possibly tighter monetary policy.

The odds are that the Fed will hike by a further seventy-five basis points at its forthcoming meeting, taking short term interest rates deep into restrictive territory, before easing back to rate of increase.

Following his Jackson Hole speech and comments from other FOMC members since, the markets should be left in no doubt as to the seriousness of the Fed to drive down inflation.

The dollar index is struggling to sustain a break above the 110 level and may see a deeper correction before rallying further. It reached a high of 110.24 but fell back to close at 109.65.

EUR – More rises to come but will likely be smaller.

The ECB delivered its largest interest rate hike in its twenty plus year history yesterday as it laid bare its inflation fighting credentials. It hiked short term interest rates by seventy-five basis points, taking rates into positive territory for the first time since before the Pandemic.

While Christine Lagarde refused to be drawn on speculation where he eventual top for rates will be, the markets believe it will be in the region of one and three quarters to two per cent.

The President of the IFO Institute, the economic think tank based in Munich commented that the rate increase was better late than never and was a step in the right direction. He went on to say that monetary policy still is very expansionary, and more work needs to be done to dampen demand.

Lagarde acknowledged that a large part of the inflationary pressures facing the eurozone currency come from external sources, but also said that the current weakness of the euro is also a major contributor.

The ECB revised its economic forecasts, it sees inflation on average at 6.85% in 2022, 3.5% in 2023 and 2.1% in 2024. Growth is headed in the opposite direction. Although the Central Bank still doesn’t see a recession, it forecasts growth at 2.8% this year and 2.1% in the two following years.

The ECB hasn’t yet begun to run down its stock of Government Bonds. Maturing paper is being replaced by fresh purchases. It is vital that this process begins soon, as delaying the removal of expansionary policy on account of an expected downturn in economic activity would push up inflationary pressures.

Supply shortages have been the main reason for the current rise in inflation, the only way to combat these domestically is to dampen demand. While that is a natural progression for luxury goods, it is hard to use a similar tactic with energy and basic foodstuffs.

The euro has further to travel before it reaches a natural base, which most market participants put around 0.9700.

Yesterday, it retreated from parity again, falling to 0.9930 but recovered to close at 0.9996.