Inflation fears remain despite more hawkish MPC

The Omicron variant Coronavirus is spreading to such an extent that the Government is unable to provide any guarantee that it will not need to introduce tighter restrictions on the public, although following yesterday’s meeting of the Cabinet it is understood that nothing is planned before the Christmas holiday.

Following last week’s interest rate hike with the likelihood that further increases will be needed in the New Year, the focus has switched to the Chancellor of the Exchequer, Rishi Sunak, and what support he can provide for several sectors of the economy that are struggling with both being able to staff their premises and also footfall at their busiest time of the year.

The CEO of one major hospitality company called on Sunak yesterday to provide support for the sector given the fact that several of his outlets are being forced to close.

Sunak will need to be careful not to set a dangerous precedent where Government support becomes a crutch for ailing businesses.

It is clear that the pace at which Omicron has risen over the past month has come as a surprise to both the Government and the scientific community.

The Prime Minister in a press briefing yesterday refused to rule out any move to combat its spread, and he repeated that such variants will only be able to be controlled if as many people as possible receive the vaccine.

There is far from complete agreement within the Cabinet over further restrictions, with one junior minister saying that a number of his colleagues will need to see more data if they are to be expected to introduce any form of lockdown.

Information such as the number of hospitalizations, the vaccination level of those who need ICU beds and the potential for the NHS to be swamped are all important considerations.

House price data for this month was released yesterday, and although prices are still rising at an annual rate of over 6%, month on month the market saw the pace of the slowdown in prices increase from 0.6% to 0.7%. This is a reaction to the withdrawal of the stamp duty holiday and while the majority of homeowners are tied into lower rates in the short term, the mortgage market is expected to be impacted more as those rates are renegotiated.

As the market begins to wind down for the Christmas holiday, expectations for the first quarter are being considered.

The pound could see renewed pressure if inflation doesn’t begin to stabilize. Despite the threat of another rate hike, both manufacturing and services output could be significantly impacted by the number of people having to isolate having contracted Omicron even in its mildest form.

Yesterday, the pound fell versus the dollar to a low of 1.3171 but managed to claw its way back above the 1.32 level, closing at 1.3201.

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Short term sentiment turning negative

The market’s general acceptance of the need for tighter monetary policy is being tested already as concerns are being voiced over the spread of the Omicron variant.

Any slowdown in activity may mean that even Fed action could have negligible effect on inflation while slowing growth significantly.

President Biden is facing a struggle to get his Build Back Better plans approved by congress. One influential senior Democrat, Joe Manchin confirmed that he would vote against, claiming that with inflation already at unacceptable levels and growth more of an issue in the short term, he believes now is not the time to inject further fiscal support.

On the subject of growth, several financial institutions are scaling back their expectations for the first quarter. The latest has been Goldman Sachs, which has downgraded its prediction for the first quarter from 3% to 2%

It is believed that Congress will eventually pass Biden’s BBB Bill in some format, but until bottlenecks in supply chains improve, growth will be sluggish.

Given how the Fed ignored inflation earlier in the year, with Jerome Powell commenting many times he believed rising prices were transitory, there are concerns that its focus will switch through 180 degrees and GDP will become secondary to its fight against inflation.

The dollar index is expected to continue to rise early in the New Year as expectations continue that the Fed will hike rates fairly soon after the withdrawal of additional support is complete. The fate of the Greenback is by no means a one-way street, with markets now having their expectations piqued by rising interest rates, if hikes don’t match their expectation, the dollar could see a significant correction no matter how dovish the ECB remains.

Yesterday, the dollar index rose to a high of 96.67 and closed at 96.53 as activity began to fall away.

Lane remains dovish in face of ECB members concern

Stories are emerging of rifts that are developing between members of the ECB’s Governing Council, following its meeting last week.

Portuguese Finance Minister Mario Centeno has been a fairly constant supporter of dovish monetary policy. Yesterday, he spoke of his concerns about continued high inflation, which, he believes, should be more closely monitored by the central bank.

However, he does not believe that the rise in infections of the Omicron variant will lead to an immediate rise in inflation. This is more likely to arrive further down the line.

Centeno and some of his colleagues have been rumoured to have pressured Christine Lagarde to acknowledge the greater upside risks of higher inflation. ECB Chief Economist Philip Lane was cast as the defender of current ECB policy in what was described as an unusually robust exchange of views.

The ECB remains committed to the transitory narrative while several Central Banks are beginning to act, some verbally others by tightening monetary policy.

The level of tension within the ECB is being ramped up by those wealthier nations who see rising inflation as a direct attack on the savings and pensions of their citizens.

Germany has already said that it doesn’t expect inflation to come back to the two percent level before the end of the year after next.

There has been a significant refocusing of the ECB’s direction under Lagarde who is championing growth and support for weaker economies, and this is seen as detrimental by the stronger nations who, in the end, are the ones who foot the bill.

The golden rule, where the nation(s) with the gold make the rules, appears to have been suspended. The question is for how long?

The euro found a little support yesterday as traders continue to square positions as year-end approaches. It climbed to a high of 1.1303 but fell back to close at 1.1277.