11 August 2022: Who remembers blackouts?

GBP – Pressure to grow on domestic electricity production

There have been reports in the press that the UK is preparing contingency plans to deal with the energy crisis that is expected to worsen as demand grows with the onset of winter.

One of the measures would be cuts in supply, or blackouts as they are called popularly, that haven’t been seen in the country since the 1970s.

This would only happen in extreme circumstances – where a gas shortage might coincide with an exceptionally cold spell of weather.

While this is only a narrow possibility, it shows the serious nature of the growing energy crisis, and how its effect could be more than simply financial.

The Deputy Governor of the Bank of England Dave Ramsden spoke yesterday of his fear that if the slowdown continues and a recession looks likely to continue, the Bank may be forced to begin a series of interest rate cuts.

This won’t happen until well into the New Year and won’t take precedence over the Bank’s continuing goal of bringing inflation back under control.

After several years of consistent monetary policy decision-making, the Central Bank now appears to have discovered changes as being something akin to a magic potion.

In its latest economic bulletin, it confirmed its belief that the economy will slip into recession either late in this year or early next and it may last until 2024. Were this to happen, no matter who wins the race to become the next Prime Minister will face an uphill task to see their Party re-elected.

Talks are taking place this week between the Chancellor, Business Secretary, and the energy firms to come up with a plan to ease the burden of energy costs for consumers.

Having resigned from the Cabinet prior to Boris Johnson’s decision to stand down, Rishi Sunak has suggested that he would be prepared to join such a meeting, but his rival Liz Truss declined, saying that she has faith in the current team to come up with a plan.

Sterling rallied yesterday as the dollar fell following the release of lower-than-expected inflation data. It reached a high of 1.2276, closing at 1.2214.

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USD – Midsummer madness sees dollar fall to six week low

The July inflation report which was published yesterday showed that headline price increases in volatile items like energy and foodstuffs moderated slightly. Core inflation with volatile items stripped out remains unchanged at 5.9%.

It is the core that the Federal Reserve is battling to bring back under control, since Jerome Powell has already remarked that there is little the Central bank can do to influence supply issues.

Wages are a significant contributor to core inflation, yet the reaction to the market of the unexpectedly substantial increase in job creation seen in July’s Employment Report was strangely muted.

There is a drag between new job creation and workers’ higher wages feeding through into inflation, so the reaction to yesterday’s data could be seen as a knee-jerk.

It is only to be expected that the Fed’s recent action in hiking rates by seventy-five basis points at its last meeting would have had some effect on inflation, and there is no real reason why one set of positive numbers would see the Central Bank alter course already.

That is especially true since the Fed professes to only look at a series of data, not one offs, and Powell is unfazed by the apparent recession.

The press continues to speculate over whether the Fed can orchestrate a soft-landing for the economy. Such conjecture is irrelevant in the current environment, since several areas of the economy continue to exhibit growth which bears no relation to the two quarters of contraction seen in general.

The continued rise in inflation, which the Fed freely admits caught it by surprise, has been exacerbated by a series of events over which the Central Bank has little or no control.

The rise in the cost of energy which coincided with the exceptional level of support provided by the Administration during the Coronavirus lockdowns and the eventual recovery from Covid which saw demand increase rapidly while supply chains took time to get back up to speed have all contributed.

The dollar index suffered yesterday as the market speculated that the fall in headline inflation would see the Fed have room to ease back on the scale of interest rate hikes.

Even if The FOMC were to decide that a further seventy-five basis point hike at its next meeting were to be unnecessary, their decision wouldn’t be based upon yesterday’s data.

Yesterday, the index fell to a low of 104.63 and closed at 105.23.

EUR – No reason to buy euro as economic situation remains dire

The economic situation in the Eurozone remains dire, with a recession coming closer daily and a series of outside events combining to make the outlook gloomier.

The continued slowdown exacerbated by the worsening energy crisis can only be exacerbated by the Central Bank continuing to hike rates. The effectiveness of any rate hike is being called into question since the ECB is continuing to provide large-scale financial support to the weaker economies.

Although this is being phased out, the bank’s bloated balance sheet will need to be addressed going forward. Any move to sell off assets bought to drive the borrowing costs of such nations will be some way down the road, but there will at some point need to be a day of reckoning, the ‘frugal five’ will no doubt insist on it.

It has become clear that the much-heralded new tools that the ECB announced recently to assist the more heavily indebted economies in lowering their borrowing costs are little more than a thinly veiled support package based upon what has gone before.

Germany has taken the opportunity to insert some new conditions that means the ECB won’t be able to act solely on the demand of countries like Italy, who have not reined in public spending since the country emerged from the Pandemic.

The German people will demand that Italians suffer similarly to them as their government instils a degree of financial discipline unheard of in Rome.

Not only is the financial situation in Italy and elsewhere causing concern in Frankfurt, but the political situation in Rome is also setting alarm bells ringing.

The prospect of the first hard right Government could lead to further disruption and a threat to the very existence of the European Union. Should the Five-Star Movement gain a majority even though a coalition with weaker partners, it will resist any moves to instil any form of control from outside. This could see a rise in calls for Italy to consider a future outside of Brussels control.

The euro has been pressing against resistance over the past few days and yesterday’s U.S. inflation data saw weak shorts stopped out of their positions.

The single currency rose to a high of 1.0368, but significant sell orders pushed it back to close at 1.0299.