Financial Policy report concerned about house prices

The Bank of England’s Financial Policy Committee published its twice-yearly report on risks to the economy yesterday, together with several changes to measures that have been in place during the Pandemic.

The Committee performed several stress tests on the outcome of the Pandemic on the financial markets and its participants, and it was decided that with immediate effect, banks would no longer be banned from paying dividends to their shareholders.

This restriction was initially put in place in March of last year to protect banks’ capital base that was expected to come under pressure from the fallout of businesses ceasing to trade. The conditions were loosened a little in December and removed completely yesterday.

The Committee noted that for a few areas of the economy, asset prices are beginning to appear stretched. The most notable is the property market, where there has been exceptionally strong growth.

The report was delivered by Governor Andrew Bailey and his deputy Jon Cunliffe.

Cunliffe remarked that growth in the property market has been driven by structural factors as well as Government support. He went on to say that the Bank is not complacent about risks of overheating in the housing market.

Cunliffe’s structural factors was most likely a reference to low interest rates that are likely to be in place for some time to come and was also probably a reference to several banks offering mortgage rates lower than one per cent for a limited period.

Today will see the release of data for inflation in June. Analysts expect prices to have risen by 2.2% year-on-year last month, up from 2.1 in May. Core inflation, which strips out volatile items like fuel and seasonal items is expected to remain at 2%.

The Bank of England’s position on inflation is now well known by the market, in that it is a by-product of support for the economy and is expected to wane as the economy reopens and support is gradually withdrawn.

Yesterday, the pound was driven lower by a stronger dollar. It fell to a low of 1.3800, closing at 1.3811.

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Signs of some contradiction in FOMC comments

Inflation in the U.S. continues to rise, with CPI in June reaching 5.4% in June. The data brought what appears to be a disagreement among FOMC members about the timing of the commencement of tapering of asset purchases by the Federal Reserve.

St. Louis Fed President James Bullard commented in light of the data that the time is right to pull back on stimulus measures, while his colleague from San Francisco, Mary Daly, believes that the Central bank will be in a good position to begin to taper by the end of the year.

There has been no comment so far from Fed Chairman Jerome Powell, although his position on the matter is well known.

Many leading banks reported their views on the data, with most commenting that they did not believe that the data changes the bank’s fundamental view on price rises being transitory. The overall view is that the economy needs the security blanket of a few more months of support.

2022 is likely to be vastly different to this year with Central banks in general, led by the ECB and Fed, turning far more hawkish both in word and deed.

There has been a degree of speculation recently that this quarter will see the peak in both inflation and growth in the economy. Factors that have driven inflation like property prices, rising oil prices and a disconnect between supply and demand are all expected to diminish gradually between now and the end of September.

Yesterday’s inflation report shocked no one, and that is a shock in itself. Inflation climbing to a level in excess of 5% would have driven the markets into a frenzy as recently as Q1 but the dollar index having risen in its initial reaction was unable to break through resistance and appears to have drifted in a well-trodden range as it awaits further notice from the Fed.

Yesterday. It rose to 92.81, closing at 92.78. The current levels appear critical. A stronger dollar will have an effect on inflation but will adversely affect the country’s trade balance as it sucks in imports, but exporters struggle to sell.

A week is a long time in economics

ECB President Christine Lagarde is perhaps not used to providing such direct guidance to the market that she appears to have made a rod for her own back.

Her announcement that next week’s ECB meeting will herald the announcement of a new policy framework has fired the starting pistol on speculation about a brave new world.

If the changes that are announced next week are considered to be more of the same with a few tweaks, then the credibility of both Lagarde and the bank will be seriously affected.

The changes to the bank’s inflation targeting appears to have been little more than window dressing and a curtain raiser for the main event.

It seems that the measures that will be announced will surround how the ECB will support the market once it withdraws direct action through a high level of asset purchases.

The inflation target will likely be the centrepiece of the new policy with the new symmetric target at its core.

Inflation has always been the main focus of the ECB. This is hardly surprising since the bank was built around the plans and outlook of the German Bundesbank.

Considering it was eighteen years in the making, the new updated forward guidance on policy rates, as it has been labelled, will need to answer several questions.

It is unlikely that the Bundesbank wasn’t pleased to see an agreement to a transition period whether inflation will be above the 2% guide since its President Jens Weidmann will be of the opinion that once the genie is out of the bottle it will be difficult to coax into a return.

The ECB’s language has been vague around what the market should expect next week. Terms like forceful and persistent monetary policy action and the period intended by the medium-term policy horizon, will need to be explained fully if they are not to become more autumn leaves blowing in the wind.

The euro suffered at the hands of a stronger dollar yesterday. It fell to its lowest level since early April, reaching 1.1772, closing at 1.1776, The magnetic pull of the year’s low at 1.1704 may now be difficult to resist but if the ECB’s credibility is affected by next week’s announcements, then the future may be bleak for the single currency.