Recession fears to replace inflation in nation’s psyche

The Bank of England may be forced to pause its current rate hike cycle for fear of tipping the country’s economy into recession.

While it seems that inflation is still limited to the supply side, caused mainly by the remaining bottlenecks in supply chains caused by the Pandemic, so far it has not spilled over into the labour force.

The country is gripped by the fears that have been created by several factors created by an unprecedented fall in the standard of living.

A slowdown in activity is being predicted by nearly every economist and market commentator as the continued rise in inflation collides with the effect of the conflict in Ukraine.

February’s growth figures will be announced later today and it is unlikely that the strong GDP seen in January will be repeated.

There were several one offs seen in the January figures for output that won’t be repeated in February. The data will show that industrial production fell from 0.7% to 0.4%, while manufacturing also fell from 0.8% to 0.4%.

The Bank of England is committed to bringing inflation back under control, but its Governor is not going to want to have to carry the burden of being accused of tipping the country into recession by being overzealous in tackling inflation having been forced to admit he was wrong in ignoring rising prices last summer.

The NIESR will publish its estimate for growth in the three months to March later today. It is predicted that GDP grew by just 1% over the first quarter.

Tomorrow sees the release of the employment report for April. The jobs data has been strong so far this year. The claimant count is expected to likely to have fallen again but not by anything the 48.8 seen in February. The unemployment rate is expected to remain below 4% but remain at 3.9%.

The Prime Minister will, no doubt, highlight the jobs data as a sign of the recovery taking hold, ignoring the gathering storm clouds for the economy. His Chancellor Rishi Sunak headwinds for his own ambitions as revelations about his wife’s tax affairs refuse to go away.

Last week, the pound fell to its lowest level this year, reaching 1.2983 but recovered to close just above the pivotal 1.30 level, at 1.3016.

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Destroying economic progress would be premature

Last week’s release of the minutes of the most recent FOMC meeting showed that the Fed remains prepared to do pretty much anything it can to bring inflation down, and judging by some of the comments that have been by Regional Fed Presidents who are not voting members this year, that should include tipping the country into recession.

These comments have led the market to believe that a fifty-basis point hike in the Fed Funds rate is almost certain at the next meeting which takes place in the first week in May.

One other significant takeaway from the minutes was a confirmation of the commencement of the reduction in the size of the Central bank’s balance sheet.

It is expected to sell off sixty billion dollars in Government bonds and thirty-five billion in mortgage -backed securities. It is likely that the final sum will eventually run into well over a trillion dollars.

The effect of these sales will be to drain a large proportion of the liquidity that was added to the economy and drive prices down. This will effectively push up medium-term borrowing costs, and, theoretically, slow inflation.

In a similar way to the UK, the Fed is toying with seeing activity slow so much that a recession is the result.

Central Bankers are not foolish with their custody of the economy but do on occasion make mistakes or misjudgements as was seen last summer, when the rise in inflation was termed transitory and due to short-term effects of Central Bank support during the Pandemic.

This was proven to be overoptimistic, and has led analysts into doubting the Fed’s current course of action.

There were calls last week for rates to be hiked to 3.5% although this is an extreme view with most expecting a pause to come when rates reach between 2.25% and 2.5%.

The dollar index continues to look towards the 100 level. Last week, it reached a high of 100.19 and closed at 99.83.

Inflation data will be released tomorrow. The headline is expected to have reached 8.3% while with food and energy removed it is still likely to hit 6.6%

Covid and inflation are twin enemies for the ECB President

It is considered unlikely that due to having contracted Coronavirus, ECB President Christine Lagarde will be unable to attend this week’s meeting of the rate-setting council of the Central bank.

There is little doubt that Ms. Lagarde will attend the meeting virtually but there is considerable doubt as to whether she will be able to avert a vote to hike short term interest rates given the pace at which inflation is rising in the Eurozone.

A counter to the argument regarding a hike in interest rates is the growing fear of a recession in the region.

Given the effect of the conflict in Ukraine on activity, there is little chance that a contraction in activity lasting more than two months can be avoided.

Headline inflation hit a high of 7.5% last month and will have several nations complaining that the stability they signed up for when accepting the Monetary Union has been abandoned Completely. The largest area of complaint is coming from those nations that are well known for their citizens being fiscally prudent and saving for either a rainy day or their retirement.

By far the most significant of those is Germany. Its Chancellor Olaf Scholz probably couldn’t have picked a worse time to take over from his long-time predecessor Angela Merkel since he has been faced with unprecedented.

Last week, Scholz was forced to virtually admit that his country is unable to function with importing Russian energy, gas in particular.

He is now faced with a dilemma of either wrecking his country’s economy or ignoring a pledge to end imports by the end of the year.

The first act of the French Presidential Election took place over the weekend. While the predicted result was that the incumbent President, Emmanuel Macron will run off against his long-time opponent Marine Le Pen, the result of that run off on April 24th is far from certain.

Macron has been accused of favouring trying to enhance his European Credentials by meeting Russian President Putin to try to broker peace in Ukraine, rather than worrying about rising inflation and falling living standards at home.

Le Pen has taken that opportunity and is reaching a new area of support which may be sufficient to get her over the line in two weeks’ time.

The euro fell to a low of 1.0836 last week and closed at 1.0877. It appears to be supported around last week’s low although any relief may be temporary.