Sunak fears rising cost of living

The UK economy is facing a series of headwinds that could halt the country’s recovery from the Coronavirus Pandemic in its tracks.

First, the number of cases of Covid-19 is beginning to rise again with fatalities at a level not seen for six months, with NHS experts calling for the reinstatement of restrictions to create a firebreak.

Second, the economy is being significantly affected by shortages of both raw materials and spare parts, as well as delivery issues that are holding up distribution of imports from the country’s ports.

Finally, the Bank of England is having to consider the possibility of having to raise interest rates to head off rising inflation that Governor Andrew Bailey has been forced to accept is likely to continue to rise or at least remain at elevated levels well into next year.

The issues being seen in the logistics sector, glibly dismissed as part of the transition away from the country’s reliance on cheap labour post-Brexit, by the Prime Minister, could easily remain an issue for a significant period, forcing another U-turn.

Bailey has already accepted that the energy storm which threatens to engulf the country will add to inflation and since there is no end to demand as winter arrives, suppliers are going to have to either pass increased costs on to customers or accept that their business model has failed.

Putting up borrowing costs will affect most areas of the economy, slowing the recovery while threatening to choke it off entirely. There are close to ten million Britons who have not seen interest rates in the country above 1% in their lifetimes, and the shock of rising interest rates could see retail sales and consumer confidence take a significant hit.

With shortages still being predicted as the Christmas rush begins, retailers will be fearing a significant slowdown in what is always their busiest period.

Fears of any return to lockdown restrictions will hit the hospitality sector hard. Staff shortages have been a major issue since the return to full operation and this is unlikely to abate and will mean that wages in the sector will have to rise in order for businesses to compete. This will add to inflation and be another issue for hard-pressed customers to face.

Despite the gloomy outlook, the pound continues to rally, driven by the prospect of an imminent interest rate increase.

Yesterday, it rose to a high of 1.3833, closing at 1.3793. It is possible that it could test 1.4000 as the next MPC meeting approaches, although it could also be limited by either a buy the rumour sell fact situation or should the Central bank decide to hold off, a correction based upon traders’ disappointment.

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Inflation not out of control but lasting longer than expected

The slowdown in its recovery that the U.S. economy is experiencing is unlikely to deter FOMC members from voting to begin the withdrawal of support for the economy.

The Federal Reserve is currently buying both Government bonds and mortgage-backed securities at a rate of $30 billion per month, and it is likely that that figure will be reduced, possibly to $20 billion, at the meeting that will be held in two weeks’ time.

Fears over rising inflation are expected to win out over concerns that the economy is not yet sufficiently resilient to deal with the withdrawal.

Fed Chairman, Jerome Powell, looks to have survived accusations of insider trading over his personal investments. He is now going to have to face up to the fact that his assertion that rising inflation will be temporary, as the facts point to an ongoing rise in prices

Supply chains are creaking under the weight of demand, which is exceeding supply, with a shortage of lorry drivers meaning that hauliers are unable to cope.

Data for the housing market was released yesterday. This also highlighted issues with the supply of raw materials.

New building permits fell sharply in September, with a rise of 5.6% in August being wiped out by a fall of 7.7%.

Housing starters also fell which is a direct effect of the lack of building materials being available.

As the recovery begins to cool, with continued rising inflation, economists are again raising the fear of stagflation. This is considered to be the economic equivalent of a Bigfoot, a monster that many feel exists but no one has actually seen.

Michelle Bowman, a Governor on the Federal Reserve Board, spoke yesterday of her expectation that heightened inflation will remain for an extended period, while her colleague Christopher Waller spoke of the need for a more aggressive set of policies should inflation remain into the first quarter of next year.

The dollar index continues to correct given the remaining uncertainty over Fed action.

Yesterday, it fell to a low of 93.50, but recovered to close at 93.78

Dovish ECB restricting euro

The current strength of the euro is still considered a temporary reaction to a weaker dollar and is simply providing sellers with an opportunity, although reduction of long position will only take place when the dollar’s correction comes to an end.

ECB Governing Council member Ollie Rehn commented yesterday that there is significant room for continued growth in the region, since there is economic slack that still needs to be taken up.

Unusually for one of the Frugal Five, Rehn, the Governor of the Bank of Finland, still believes that rising inflation is transitory. He reverted to film by saying that if it exists much longer, it could begin to affect expectations. In other words, we will call it transitory for now, but if it fails to abate soon, we will find an alternative title.

Rehn is confident that the Central bank will not overreact, although so far, the comments from the ECB President leave the market almost certain that an overreaction is something far from her mind.

Most of the ECB Governing council have a date in their diaries of the end of March next year for the beginning of the taper of additional support.

While the current level of support appears excessive given the data that is currently being produced, Christine Lagarde remains determined that the Central bank will, if anything, keep at this level even at the risk of fuelling inflation.

ECB Chief Economist Philip Lane spoke yesterday of his difficulty in following the market’s current expectations, given that advance guidance has been clear and unlikely to change.

Despite Lane’s comments, several banks have issued predictions that the current rise in the value of the euro is temporary and current monetary policy will eventually lead the single currency to test the 1.15 level versus the dollar.

For now, however, the euro has the wind beneath its wings. Yesterday, it rose to a high of 1.1669, closing at 1.1633.