Bailey again calls for pay restraint

It is becoming a familiar struggle as Central Banks grapple with inflation while being mindful of the effect that the conflict in Ukraine will have on growth.

The Bank of England’s monetary policy committee meets next week and will face an extremely tough decision that goes well beyond individual members’ view of the economy.

Since the invasion of Ukraine began, there have been very few interviews or even sound bites provided by MPC members, so it is difficult to gauge their mood.

It is unlikely that the unanimous decision to hike rates that was seen at the last meeting will be repeated, particularly since the committee will be aware of the headwinds that will be created next month when the fuel cap is increased, and national insurance contributions are increased.

Mortgage interest rates are now rising, and the deals that banks were able to offer have become ever shorter in tenure. This reflects the view that rates will continue to rise.

Over the past couple of weeks, there has been a series of dire predictions concerning the UK economy as energy prices have continued to rise. Former Minister Robert Jenrick spoke yesterday of his fears that the country is facing its toughest year in a generation, while also adding to fears of an energy crisis to rival the 1970s.

The price of a barrel of Brent Crude has moderated a little this week, but it still has the potential to rise further. Relations between the west and the Middle Eastern oil exporters are still difficult, with Saudi Arabia’s Crown Prince still smarting from criticism of his apparent involvement in the death of activist and journalist Adnan Khashoggi.

The Prime Minister has bought some time for the country to find another source following the decision to ban imports of oil and gas by the end of the year. So far, the sanctions that have been introduced by NATO members, while having a significant effect on the Russian economy, haven’t begun to bite into the resolve of President Putin and his inner circle.

The nascent possibility of a negotiated settlement of the conflict saw risk aversion in financial Markets begin to bottom out yesterday. The pound made gains versus the dollar, rising to a high of 103189, closing just a few pips lower at 1.3185.

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Hawkish tendency to await end of conflict

Prior to the beginning of the conflict in Ukraine, the financial markets were prepared to ignore the dire warnings emanating from the Administration about the build-up of troops on Russia’s border.

This was a contributory factor in the growth in expectations that the Fed would begin its tightening of monetary policy with a statement hike of fifty basis points.

In keeping with the radio silence that has been seen by members of the UK MPC, Regional Federal Reserve Presidents, whether FOMC members or not, have kept their own counsel over the size of the hike that will be voted on at next week’s meeting.

The past two employment reports have provided upside surprises, but job vacancies in the U.S. remain at historic highs.

There were still close to eleven and a half million job vacancies in the country at the last count, and this is leading to the level of wage inflation that the Fed is concerned about. Having seen price rises limited to the supply side of the economy as consumer inflation has risen to a high of 7.5%.

The market has tempered its expectations for next week’s hike, and the prediction is for a twenty-five-basis point increase in the Fed Funds rate.

However, there is still a school of thought that believes that the Fed should strike while the iron’s hot, and hike by fifty, to catch up with inflation that will continue to rise as the cost of energy remains significant.

Next week’s meeting will solely concentrate on a tightening of monetary policy through a rate hike, with the start of a reduction in the size of its balance sheet not slated to begin until interest rates have begun to normalize.

It is likely that any mention of balance sheet reduction will be limited to an acknowledgement from Chairman Powell in his comments that it is something that will be addressed down the road.

The recent rally seen in the dollar index abated yesterday as risk appetite returned to the market, albeit tentatively.

The index fell to a low of 97.85, closing at 97.95. Predictions of a rise to the 100 level now look premature.

While inflation is still at an average of 4% for 2022

With activity and output moving in the opposite direction to inflation, ECB president Christine Lagarde will face yet another demanding situation following today’s rate setting meeting.

The pressure from the more hawkish members of the committee to begin hiking interest rates should have eased considerably following the Russian invasion of Ukraine.

The negative outlook for the economy has increased exponentially despite the continued rise in inflation.

The sanctions that have been imposed upon Russia will have a negative effect on growth, while the significant decrease in the level of energy imports will have a major impact on the larger economies, Germany in particular.

The headwinds that are facing the European Union have led to continuing concerns about the region’s united response.

Again, European Union President Ursula von der Leyen has not been seen as a unifying force, apparently preferring to leave comment to Scholz, Macron and to a lesser extent Draghi.

French Finance Minister, Bruno Le Maire, spoke yesterday of rising inflation being linked to soaring energy prices. He considers another, whatever it takes, economic plan to be unnecessary, and appears to want to treat inflation with a Gallic Shrug.

In much the same way as the FOMC, now not considering a fifty-basis point hike, expectations of a rate hike by the ECB this year have faded. It is now generally agreed that the ECB will begin its tightening cycle in 2023.

It is probable that Lagarde will allude to this when she speaks to the press later this morning.

The euro reacted positively to the possibility of a negotiated settlement in Ukraine, rumours of which appeared yesterday.

It is now, however, out of the woods since the market was extremely bearish even before the invasion.

Yesterday, the single currency rose to a high of 1.1095, closing at 1.1070.