Data challenges BoE belief that rises will be temporary

Data for consumer price inflation was released yesterday. It showed that the headline figure rose to 2.5%, its highest since August 2018. The median forecast was for a rise to 2.2%.

With producer prices which show inflation at the factory gate also rising, it is likely that rising inflation will be a feature of the economy for several months.

This could mean that the Bank of England has to review its strategy for supporting the economy into next year, as it could be forced to raise interest rates as soon as Q2 ’22.

As central banks in the developed world switch policy from being proactive to reactive, this rising inflation was the issue that caused most concern. Since the recovery began in earnest, there have been conversations being had about just how far inflation can go.

Despite sophisticated modelling tools and techniques, every bank appears to have been infected with another virus, wishful thinking.

Having fallen in 2020 the cost of fuel, food, clothing and eating out have all recovered and this has, to a certain extent, exacerbated the increases.

The Bank of England is sticking to its line on inflation, still labelling the rise as transitory. Its Deputy Governor Dave Ramsden said in a speech last evening that inflation could reach 4%, citing the strength of the recovery and persistent imbalances as the main reasons.

The jury is still out as far as the financial markets are concerned. With employment still well below pre-pandemic levels and two million workers still on furlough, there are still several factors to be added in before the picture becomes clear.

The pound rallied following the release of the data. This coincided with a weaker dollar and pushed Sterling to a high of 1.3891, but it ran into a degree of selling pressure, and drifted back to close at 1.3860.

Employment data will be released this morning, The headline rate is expected to be unchanged at 4.7%, although there is expected to be a healthy decline in the claimant rate of close to 100k.

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Support to remain in place

Jerome Powell, the Chairman of the Federal Reserve, in yet another of his semi-annual testimonies to congress reassured the administration that he has a strong hand on the tiller, and support for the economy will stay in place despite rising inflation.

The certainty with which Powell asserts that the current level of inflation, whilst higher than the FOMC had expected, remains transitory. He explained to congress that the pace with which the economic landscape has changed as the economy has reopened means that an overshoot was likely.

Congressmen will be entitled to ask if such an overshoot was so likely, then why didn’t you warn us before. That question was not seriously asked, so it appears that Powell retains his Midas touch.

Powell came armed with a long list of reasons why inflation continues to rise. There have been bottlenecks in the auto industry caused by a worldwide shortage of semiconductors and employment has not risen as quickly as had been expected, due in part to the stimulus cheques that those hit by the Pandemic have received.

The Fed continues to be driven by the policy goals handed down by Congress of maximum employment and price stability. The economy remains on course to achieve its highest growth in decades.

There are record numbers of job openings and hiring is still strong. The rise in wages has been exacerbated by workers moving jobs as better opportunities arise. This has also fuelled inflation.

Seven of the twelve regional Federal reserves have reported strong price rises, with some businesses seeing bottlenecks pushing prices up even further.

However, as coronavirus restrictions ease in most States, the priority will switch, and supplies should gradually return to normal.

The market remains reasonably confident in the dollar’s ability to continue its recent return to higher levels, but for now its progress is restricted by strong resistance around the 92.80 level. Yesterday, it retraced within its current range, falling to 92.34 and closing at 92.36.

Jobless claims will be released later today, and the market will be looking for a rebound following last week’s weaker than expected data. Also manufacturing indexes will be released by the New York and Philadelphia Feds, and traders will be looking for Powell’s words to be backed up by solid data.

Full year growth expectations increased

The Eurozone economy began to fight back against the Coronavirus Pandemic in the second quarter of the year, as the ECB’s policy of throwing as much support as it could muster behind the problem paid off.

There are still concerns that vaccine resistant strains of the virus could emerge as the economy opens up, which could easily blow the recovery off course.

The level of infection that has been seen in the Netherlands since the economy was almost completely reopened has the authorities worried. Infections are up by 500% although in keeping with other countries, infections have not heralded a rise in either hospitalizations or fatalities to anything like the same degree.

ECB President, Christine Lagarde, has created an almost frozen state for the market with her announcement that next week’s Central bank meeting will contain new guidance for monetary policy that will be implemented once the current support is tapered.

Given the way the market has viewed the credibility of the Central bank in the past, traders and investors will want to see Lagarde put some meat on the bones of her announcement before passing judgement. What this means is that until it gets the details, the market isn’t prepared to take any fresh positions.

Unfortunately, experience has taught analysts to be cautious about grand pronouncements from the ECB, which have often contained caveats and event driven clauses.

Lagarde’s colleagues on the ECB’ General Council will be continuing to worry about rising inflation, having seen stronger than expected data from both the U.S. and UK. While the ways support has been delivered have been different, the issues facing a recovering economy remain similar.

This week has seen a light data schedule for the Eurozone which has allowed traders to speculate over what the new deal will be although, its implementation will be something of a moveable feast, unlikely to being for more than six months.

The euro rose yesterday as the dollar index fell. It reached a high of 1.1838, closing at 1.1836. The 1.20 level remains well out of reach but, for now, the inflationary effect of a weaker currency has been held at bay.