5 August 2022: Stagflation: the Bank’s core view

GBP – Rising inflation to drive further rate-hike despite recession

Following the meeting of the Bank of England’s Monetary Policy Committee which concluded yesterday, the Bank’s Governor Andrew Bailey painted a particularly stark picture of the economic outlook for the next twelve months.

Hiking rates by fifty basis points, the largest increase in twenty-seven years, Bailey confirmed that tackling inflation remains the Bank’s most important task.

The report on the economic outlook made particularly depressing reading. It predicts that inflation will peak at 13.5% in October, coinciding with the next increase in the Ofgem energy price cap, and a country soon to be in recession.

One of the more surprising predictions is that the Bank expects the recession to last for up to a year.

Should the prediction for inflation be proven to be correct, it will mean that prices rises will be increasing at their highest rate for 42 years.

Conservative Party Leadership Candidate Liz Truss spoke yesterday of her intention to investigate the Bank’s continued independence since she believes that it made a possibly catastrophic error in not being more serious in tackling inflation.

This would reverse the decision made by Gordon Brown when he was Chancellor in 1997. While this may appear to be a radical, headline grabbing suggestion, there have been questions being asked for some time about what the Government isn’t represented on the MPC.

Former MPC member Professor Danny Blanchflower spoke yesterday of his belief that the Bank’s recent performance, culminating in the size of yesterday’s rate hike, may prove to be an electoral disaster for the Government. He believes that whoever wins the election of September 8th will be handed a poisoned chalice.

Blanchflower, while criticizing incompetence and group think, went on to say that were he still a member he would have voted for a cut in interest rates yesterday, flying in the face of the current fashion to raise rates to tackle an inflation for that is immune to such actions.

The bleak outlook for the economy was by little reaction from the financial markets. Sterling fell only slightly against the dollar, reaching a low of 1.2138 and closing to that level.

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USD – Fed still a long way from beginning to cut rates

Several eminent economists have commented recently that the only way that inflation will be brought under control in the coming months is if the employment market sees a sharp and sustained correction.

While weekly jobless claims are beginning to rise, the fate of change is not unusual and certainly not something that will begin to add to concerns about the depth or length of any recession.

As predicted, jobless claims reached 260k in the most recent reporting period, taking the four-week average to 254k from 248k.

The Challenger report on lay-offs was also released yesterday. Although there is no significant correlation between this and the report that will be released later today by the U.S. Bureau of Labor Statistics of non-farm payrolls, it still attracts the market’s attention.

While the headline number is generally ignored, the trend is considered to be important, as is the size of difference between the latest read and the previous two or three. lay-offs fell from 32.5k in June to 25.8k in July.

This proved to be something of a surprise for the markets, given the recent steady increase.

The most recent prediction for today’s employment report is the headline NFP to fall to around 250k from last month’s 372k. This prediction is similar to last month, when the market was surprised by the continued strength of the data.

While it highlighted the current level of mistrust between Washington and Beijing, the Chinese reaction to Nancy Pelosi’s visit to Taipei has been both predictable and something of a storm in a teacup.

No one doubts the genuine desire of the Chinese Government to take back the island, which declared its independence from the mainland close to seventy-five years ago. Similarly, in which it bided its time over Hong Kong, Beijing will not wish to act precipitously and be seen as unnecessarily aggressive.

A rise in global risk appetite pushed the dollar a little lower as the market returned to its deliberations on global inflation risks and an economic downturn.

The dollar index fell to a low of 105.86 closing just above that level. The uncertainty about the future path of interest rates in G7 nations as recession fears grow will have a major effect on currencies, and today’s NFP may be considered a watershed if it marks the beginning of a major dip in job creation.

EUR – Consumers braced for double whammy

The consensus view of the populations of Eurozone nations is that the ECB has not performed well over the past year.

There is a clear national split regarding what should have been done to combat inflation when it first became an issue early in the first quarter, although citizens of Italy, in particular, believe that they should have received greater support.

At the risk of repeating a recurring theme, the reality of one size fits all is that it works no better in economics than it does in almost any other walk of life.

The continued argument regarding the tools that have been developed is testament to the fact that weaker nations will always require a bailout, or at least strong support from more disciplined ones.

In the past, the main reason that Germany and other stronger economies were prepared to do this was that they were benefitting from the deal. Now, the German public, faced with an unprecedented energy crisis, are rightly asking “what’s in it for us?”

It is unacceptable for the current generation of Germans to have seen their parents and grandparents struggle to rebuild the nation and make it a global industrial powerhouse, only for weak economies driven by ill-disciplined financial and social actions to threaten a return of instability.

The entire fabric of the machine that is the European Union needs to be torn down and rethought, but there is no politician who is sufficiently European in outlook, or who carries sufficient gravitas to accept the role.

Self-interest is growing, as was seen at the time of the initial lockdowns. This was exacerbated with the unseemly scrap over the distribution of Coronavirus vaccines.

While a Fiscal Union would provide a framework for a new, more unified EU to be built, the question remains if that is what the population really want. Again, it will be decided by affordability and what’s in it for me, thinking.

The euro is adrift on a sea of uncertainty currently as global concerns drive the market. Yesterday, it remained trapped in a narrow range, closing at 1.0242.