23 December 2022: The signs of a recession are rising

The UK economy shrank by more than expected in Q3, leading commentators to agree that the recession has not only started, but it will be initially deeper than had been predicted.

Most observers accept Bank of England Governor Andrew Bailey’s belief that the economy will spend at least five quarters in recession as it struggles with high inflation, which means that its ability to provide support by loosening monetary policy if greatly reduced.

With short-term interest rates at their highest level for fourteen years, with more hikes to come in the New Year, Central bank actions can only prolong the recession while they hope to see inflation fall back close to its 2% target by the end of the third quarter.

There is no sign of any breakthrough in the wave of industrial action that has swept the nation during the current quarter, and this is leading economists to predict that the economy will have contracted by close to 1% between October and December.

With strikes hitting a number of sectors, their numbers will be bolstered by border force personnel who begin action today. That will add to the misery of those hoping to get away during the holiday period and will add to severe queues at points of entry into the country upon their return.

While borrowers are suffering from the rise in interest rates, savers are beginning to see the benefit as major banks raise the rate of interest they are earning on deposits. While inflation was low and rates fell close to zero, savers were unable to see any return on the funds.

There have been several predictions made regarding the fate of Sterling in the New Year, with most expecting it to suffer, despite the fact that the Bank of England is likely to continue to hike rates for longer than the Federal Reserve which is expected to begin to taper the size of its own rate increases within a month or two.

The ECB looks likely to continue to match the Bank of England, as both economies fall into recession, which should boost the dollar index.

2022 has seen the return of Central Bank policy to the fore of traders’ minds and that is likely to remain the case at least until inflation has fallen back to target.

Yesterday, the pound fell to a low of 1.1992 versus the dollar but recovered to close at 1.2041.

According to many predictions, the U.S. economy should have begun to shed jobs by now, as the continued raising of interest rates restricts demand and economic activity lower.

While weekly jobless claims have remained at between 190k and 210k for most of the past two quarters, the headline new jobs created figure has fallen to around 250k.

Given that several commentators expected a recession to blight the economy with non-farm payrolls falling into negative by the end of the first quarter, activity has fallen but still remains positive.

With the Federal Reserve continuing to talk the talk without walking the walk, on tapering interest rate increases, the economy is not receiving the support that would be expected at this stage of the economic cycle.

While the minutes of the November meeting of the FOMC portrayed a level of uncertainty about the future path of short-term rates and Jerome Powell was neutral in his latest speech regarding slowing the rate of increase down, the December meeting pulled back for yet another jumbo seventy-five-point hike, although it retains a tightening bias.

The data and monetary policy actions of the first month of the year will likely determine the path for the first quarter and possibly beyond. Any headline figure above 200k in the employment report and a continuation of the recent fall in inflation will see the Fed continue to hike rates, although they will moderate the increments.

The dollar index is expected to be comfortably able to hold its ground as other G7 economies suffer. The reduction of restrictions due to Covid recently seen in China should provide the U.S. economy with a boost.

The Dollar index continued its recent theme of bumping along the bottom of its recent range yesterday. It rallied to a high of 104.60, but fell back a little to close at 104.39.

One of the main reasons that Germany finds the continued increase in inflation unsettling is the effect it has on the value of the currency. The opposite is also true, as a weak currency also raises the spectre of higher inflation.

While several of its partners in the Eurozone have levied historically with a weak currency, which has allowed them to export more goods, even if it makes their imports more expensive.

The entire economic history of mainland Europe has been turned on its head with the continued evolution of the Eurozone. German ambition to be the strongest and most powerful economy in the region has had to be tempered as it has ceded control of its own monetary policy to the European Central Bank.

Germany has seen its economy continue to weaken this year, and it is likely that it will declare a recession sometime in the first quarter. It is fairly clear that Germany has been targeted by Russia in retribution for the sanctions that have been placed upon it over the invasion of Ukraine. The rise in the wholesale price of gas together with the disruption of supply have seen German industrial production fall into contraction.

The quest to bring inflation under control is continuing, although it looks as though price rises have topped out, but that could easily turn around as winter reaches its peak. The fall in the forecourt price of fuel has had a positive effect on headline inflation, but the core remains stubbornly high.

Using an average of rates of inflation, across a disparate range of economies leads to anomalies in the rate, and it is a fact that very few, if any members of the Eurozone actually have an inflation fate that can be considered average.

The ECB faces continuous pressure to come to the aid of the more indebted nations, both by reducing the pace of interest rate hikes, but to also inflate its own balance sheet by continuing to act as a lender of last resort by buying their bonds. This keeps the prices high as in effect there is an implicit guarantee in place.

The euro has managed to hold its head above water over the past few months, rising above parity with the dollar. That will remain a target for bears over the next few months, while the all-time low of around 0.88 is possible as the U.S. economy generates growth while the Eurozone, despite relatively high interest rates, continues to suffer.

Yesterday, the single currency continued to drift, closing at 1.0597 having earlier fallen to 1.0573.

Have a great day!