Falling Covid infections add to higher growth expectations

To start with a cliché, today’s Bank of England Monetary Policy Committee meeting is potentially one of the most important in living memory. Either that, or the MPC members will simply agree among themselves that the time isn’t right for a tightening of policy and the market will enter its summer lull, none the wiser.

As with most such decisions, the likely outcome won’t be as clearly defined. Just about every action, every word of Andrew Bailey’s statement, and his answers to questions in the subsequent press conference will be either open to interpretation or ambiguous.

The first of the ambiguities will be the votes. There is little doubt that the vote on a change to interest rates will be 9-0. There is no belief among MPC members that interest rates need to rise, despite inflation.

It is likely that Bailey will continue to use the transitory mantra, but there are some who feel that unless dealt with, the return of inflation could be permanent and become a self-fulfilling prophecy which drives pay demands, particularly in the public sector, significantly higher.

That is something that Rishi Sunak will not want to contemplate, and a reason why above target inflation usually demands an explanation from the BoE Governor to the Chancellor.

The probable outcome will be a 7-2 vote for a cut in asset purchases and slightly more hawkish comments from Bailey. Most of the members’ voting decisions have become evident from their most recent comments, but there may be one of two who are still on the fence.

A 6-3 vote in favour of leaving purchases as they are, would be the most hawkish outcome that could be expected.

The economy is continuing to recover and there is no sign of any slowdown following the removal of several of the Government’s supports. The most prominent was the removal of the stamp duty holiday, which, for now, has seen the market continue to perform strongly.

The reduction in the level of support that businesses receive in furlough payments has also begun to be gradually reduced, but the effect will take a few months to feed through. For that reason, Sunak is expected to delay the delivery of his budget until the new year.

The pound fell yesterday in response to hawkish comments from a senior FOMC member (see below). It reached a low of 1.3885 and closed at 1.3889.

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Services sector growing despite supply constraints

The Vice-Chairman of the Federal Reserve, Richard Clarida delivered one of the most hawkish statements to be seen by an FOMC member for a considerable time.

Clarida’s comments, coming from a man who is both in the know, and unlikely to say anything that is not either a reflection of Jerome Powell’s thinking or very close to an agreed policy.

It would be something of a PR disaster for the Fed if its top two officials weren’t singing from the same hymn sheet.

Clarida virtually confirmed that the tapering of asset purchases will take place this year and that conditions for a rate hike should have been met by the end of next year.

Popular opinion had been beginning to turn to a view that the Fed wouldn’t be able to wait until 2023 for its first hike of the cycle, so Clarida pretty much confirmed the view of the market.

This was not so much a bombshell or the market, as a perfectly legitimate delivery of advance guidance, in lieu of an FOMC meeting this month.

Data released this week was unlikely to have been in any way a contributory factor in Clarida’s comments since single data releases are not considered sufficiently reliable. It is the trend that is important.

St. Louis Fed President, James Bullard also had some hawkish words to say about inflation. He believes that inflation is going to be a factor for far longer than the market expects, and they are well-prepared for the taper to begin.

Powell is awaiting news from President Biden of his confirmation for a second term of four years at the helm of the Central Bank. If Powell were not to get the nod, and that is unlikely, then Lael Brainard who is responsible for financial regulation and was praised in Congress earlier in the week for her suggestions for a tougher regulatory regime, would be a shoo-in

The data released this week has been largely supportive of the taper of support with services only held back by supply issues.

The dollar index rose following the hawkish comments. It reached a high of 92.31 and closed at 92.27.

Italy and Spain outshining France and Germany

It may be a little impolite to call Spain and Italy second tier members of the Eurozone, given the size of their economies, but they have leapt in importance to the recovery of the region, performing strongly in Q2.

With France continuing to struggle, particularly when getting the Delta variant under control, the Eurozone may have found itself still in recession with the contribution of these two supposed high inflation high interest rate economies.

This may be a significant signal in other ways too. It may be that both the Spanish and Italian economies are beginning to be able to exist without constantly banging heads with Brussels over budget deficits and debt to GDP ratios.

That remains to be seen, but the future is beginning to improve as tourists begin to return to both countries.

Access the entire region. The reopening of the economy has provided consumers with a chance to spend the excess savings they had built up over the period of the lockdown.

The second phase of the reopening where hospitality has been allowed to also reopen has seen a move away from purchases of goods to a significant switch to consumption of services like restaurants, bars, and theatres.

Estimates for services output rose in July by one of the largest amounts ever. This coincides with the level of those having received both doses of the vaccine and sets the region on a path to even higher growth and activity in Q3 and H2.

The euro remains reactive to the dollar, having benefited from the changes in ECB policy announced recently. The big question regarding withdrawal of support is still several months away.

The single currency fell to a low of 1.1832 yesterday, closing at 1.1836.