Tightening to come from QE, not rate rises

Andrew Bailey, the Governor of the Bank of England has had a far more seamless transition into the role than his ECB counterpart. Promoting from within has allowed continuity and given Bailey the tools to deal with the issues facing the UK economy.

Bailey spoke at the Jackson Hole Symposium on Friday about the Bank’s tactics and likely actions going forward. One of the more impressive parts of the UK’s reaction to Covid-19 has been the partnership between the Central Bank and Treasury.

Bailey spoke of the fact that the Bank of England, far from running out of options going forward, still has sufficient firepower to counter any slowdown in the recovery. He reiterated his belief that big, bold policy moves are the most effective way to deal with crises such as the pandemic and instil confidence in the public.

Using different methods but coming to the same conclusion as Fed Chairman Jerome Powell, Bailey intimated that by lowering the level of QE, he will be in a position to tighten monetary policy while still leaving interest rates at current levels. This should be considered a sea-change in monetary policy on a par with the Fed’s new policy over inflation

Chancellor Rishi Sunak is still grappling with how to pay for the additional support that was given, and may still be needed, to prop up the economy. The UK papers have got wind of tax increases and a raid on state pension funds, both of which will be highly unpopular. Sunak still has time to come to a decision, but that decision may be the making or breaking of his nascent political career.

Last week the pound rallied as the dollar fell following Powell’s comments. Sterling reached a high of 1.3356, closing at 1.3350. Liquidity may be thin today with the UK on holiday and investors still on the sidelines.

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This week’s NFP to follow Jobless claims pattern?

Employment remains the most significant and obvious sign of the strength or otherwise of the overall U.S. economy.

Last week’s weekly jobless claims data showed that the patchy improvements that had been seen since the loosening of lockdown have ground to something of a halt and fresh impetus is necessary.The week will be dominated by this week’s August employment report.

With the dollar on the backfoot already following the Fed’s move to average inflation as a target for monetary policy, should the markets be convinced that the recovery of the economy is going to take longer than the Administration believes, the greenback’s suffering may be far from over.

President Trump, under pressure over continued public unrest, has flip flopped during his Presidency over the dollar and has appeared behind the curve on a few occasions. When he first came to power, he berated other G10 members for allowing their currency to weaken to give them an advantage, thus favouring a weak dollar almost by default.

He then appeared to change his mind and is now promoting a strong dollar as an indication of the country’s dominance and a further sign of economic strength.

The strengthening of the Chinese Yuan as it has broken the 7.00 level has barely been mentioned. This should make U.S. exports cheaper but will have a negative effect on the trade balance in monetary terms. On Friday, the Yuan closed at 6.8491, its highest level since January.

With the market still chewing over Chairman Powell’s revelations, ongoing spats over civil unrest between Trump and Biden and the close proximity of the employment report, this could turn out to be a significant week for the dollar as the summer lull comes to an end, marked by next Monday’s Labor Day holiday.

Last week the dollar index was on the back foot driven first by concerns over Powell’s speech then by confirmation of the changes to monetary policy. It fell to a low of 92.20, closing at 92.28. There looks to be a degree of support around the 92.10/20 area but a close below there could open up a fall through the 90 level, giving a boost to both the single currency and Sterling.

Virus picking off economies one by one

Since the European Union continues to eschew policies that would make the sheer size of the region an advantage when it comes to trade and economic activity, a strengthening euro will be a concern both Brussels and the ECB.

Germany, despite its recent comments over the unity of the Union and its financial commitment to Brussels still appears to have one foot outside as it continues to try to command a greater share of global export markets.

As the U.S. continually threatens tariffs on several EU manufactured products, the entire region, but Germany in particular, would do well to consider how they can take advantage of potentially their biggest asset.

Data released last week showed that Germany is beginning to see the confidence of both the public and the business community beginning to improve.

The influential IFO Institute produced its monthly index of business climate and expectations. Business climate and the current assessment were above market expectations while expectations were above last month’s level but were a shade lower than the market expected.

This shows that there are still concerns over a second spike in Covid-19 and the effect on the economy should it be decided that borders need to be closed or at least be more strictly monitored.

With the Fed and Bank of England having been prominent by providing significant guidance on their intentions, the spotlight will fall on Christine Lagarde, the ECB President to consider what measures she can take to contribute to an improvement in the economy.

It is almost as much a matter of market confidence as it is practical steps that will see confidence improve.

Last week, the euro continued its rise versus a weakening dollar. Any approach towards the 1.20 level will sound alarm bells for the competitiveness of the region. It rose to a high of 1.1920, cloning at 1.1903.