19 May 2022: 10% inflation on the horizon

Sunak and Johnson, under pressure to relieve its effect

Headline inflation rose, as predicted, to 9% in April, that is a full 2% higher than it was in March.

The main culprits, over and above energy, were lamb, milk and sugar. Shortages are continuing to push prices higher.

The Office for National Statistics saw 78 of the 80 prices it monitors rise in April.

Many products that are traditionally produced domestically saw significant rises, even more than headline. Butter and milk soared by 11.8% and 13.2% respectively. However, the 54% increase in the energy price cap was by far the most significant increase.

The rise in the cap together with wholesale gas and fuel costs means that energy contributes more than 33% of inflation.

It may be that the rise into double figures will be delayed for a couple of months as shortages ease. The major issue in the coming months will be a further increase in the energy cap, which is expected in October.

Although Andrew Bailey has accepted that inflation may reach 10%, there are several; observers who believe that April’s figure will be the top. The Bank of England does believe that inflation will be back below target by the end of next year, although the fall will be gradual and barely noticeable in the short term.

There are moves being considered by the Government to introduce adjustment(s) to the cap on a quarterly basis that would allow it to fall as well as rise.

Chancellor of the Exchequer Rishi Sunak is apparently working on a proposal to reduce business taxes. While this may satisfy the majority of those who traditionally vote Conservative, The Labour Opposition is certain to criticize this as such a plan would take a significant time to reach workers, if at all.

Were business taxes to be cut, there is no guarantee that it would feed through into lower retail prices or, indeed, higher wages for workers.

In financial markets, there is a feeling that the Monetary Policy Committee is reluctant to continue to hike rates, while the Federal; reserve is a willing participant, having seen asset markets take their policy in their stride.

Also, the EB is about to begin a programme of hikes, and while there may be some push back, in order for inflation to be brought under control.

That may have a negative effect on the pound. Yesterday, it fell versus the dollar to a low of 1.2371, closing at 1.2399. Against the single currency, it fell to a low of 1.1770 and closed at 1.1809. Sterling is particularly volatile versus the euro currency, although it is trading in a wide 1.1900 / 1.1650 range.

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House loan leverage being cut

Yesterday’s housing market data in the U.S. was a direct reflection of the determination of the Federal Reserve to bring inflation under control by significantly tightening Monetary Policy.

The fact that the Fed was going to begin to raise rates was anticipated by the financial markets, where mortgage rates have been being raised for a few months.

This has, in turn, fed through into the housing market. Housing permits fell by 3.2% after a rise of 1.2% in March.

Housing starts also fell, by 0.2%, although they had fallen by a far more significant amount in March as builders anticipated a possible oversupply.

Banks have been forced to reduce the leverage they are prepared to offer potential house buyers, while higher rates are also deterring buyers committing to moving house since they see rising interest rates as a relatively short-term phenomenon.

Jerome Powell is in an unenviable position as the Chairman of the Federal Reserve, presiding over the highest level of inflation since the early eighties, but is Powell to blame?

In his favour is the fact that all G7 economies are suffering from high inflation, which is expected to be combatted by tighter monetary policy.

Against Powell is the fact that he chose to label inflation as transitory in the summer of last year, which it clearly, with hindsight, was not.

In a speech on Tuesday evening, Powell commented that the Fed will have to start moving more aggressively if inflation does not respond to rising interest rates.

Powell has become progressively more hawkish over recent weeks and months, but he does have a team of cheerleaders in the shape of the FOMC who agree with almost every comment he makes.

Tuesday’s speech finally saw socks begin to move lower as Powell’s words indicated an even more hawkish stance.

Retailers were the worst hit. This is in spite of the fact that the consumer has stood up well, as evidenced by recent data for retail sales.

It may be that if the Fed is seen as not yet being able to bring inflation under control, Consumers may see fit to put seeding plans on hold until the situation becomes clearer.

The dollar index began to recover recent losses as the threat of higher rates encouraged buyers. It rose to a high of 103.77 and closed at 103.68. The 105 level looks a distant target for now, and it will probably take a greater divergence of policy to see it test that level again.

Bank could see more bad loan problems

Eurozone banks are holding a significant volume of bad loans on their balance sheets that they have not been in a position to divest themselves of during the Pandemic that saw the economy falter before recovering.

The conflict in Ukraine as well as the threat of higher interest rates is raising concerns about the bank’s financial stability again.

Christine Lagarde has presided over a significant fall in the strength of banks’ balance sheets. It is likely that she is concerned about a weakening of this position that could lead to a significant fall in their ability to lend to their clients, given that they will need to raise more capital in order to see their ratios improve.

Speaking yesterday, Lagarde asked the ECB’s board members to allow nation Central Bank heads to have more say on policy.

While this is a sensible move, it may lead to greater conflict over interest rate policy, since there are nations who are comfortable with inflation running at a rate higher than the ECB target while the frugal five believe that inflation should remain well below the target and be controlled by higher interest rates.

There was a fall in headline inflation reported yesterday. It fell from 7.5% to 7.4%.

There will be another inflation report before the ECB makes a decision about raising interest rates. If it is felt that inflation is beginning to fall, Lagarde and the more dovish members of the Governing Council may prevail, and the hike could be delayed.

The ECB has something of a reputation for sitting on its hands while the situation develops. The growth and stability pact is now considered dead in the water, and Germany will be one nation pushing for it to be reinstated as debt to GDP ratios and budget deficits continue to appear out of control.

Any conversation between Italian Prime Minister Mario Draghi and his German counterpart will be interesting given that Draghi is now presiding over one of the economies that has been considered profligate in the past, yet Draghi is considered to be the man who saved the euro.

Despite the market’s attitude to Sterling, which appears to be caught between the devil and the deep blue sea, it remains the euro that is expected to break below a significant level first.

Yesterday, the euro fell to a low of 1.0475, closing at 1.0477.