10 January 2023: Pill sees high rates continuing

In an interview yesterday, Huw Pill, the Chief Economist of the Bank of England, reiterated his belief that short-term interest rates in the UK will continue to rise as the Central Bank remains committed to bringing inflation under control.

He went on to say that he and his colleagues on the Monetary Policy Committee see inflation as potentially the most serious danger facing the economy and although fuel and energy prices appear to be moderating which will see headline inflation fall, there remain a number of areas, like accommodation rents that are rising at a record pace. This will see core inflation continue to raise concerns.

Pill affirmed the commitment of the MPC to fulfilling its mandate to return inflation to its 2% target. This is the core commitment of the Central Bank, and it is prepared to do whatever is necessary to achieve this.

The global economy is coming out of a long period of supportive monetary policy and all G7 Central Banks have a shared commitment to fight inflation, although the causes of higher prices vary as do the methods other than monetary policy used to reduce it.

There are common themes like the war in Ukraine that have driven prices higher over the past year that have conceded with the end of the Pandemic, although the infection rate in China and its withdrawal of travel restrictions are still a concern.

The UK economy is facing unique challenges, driven by the country’s withdrawal from the European Union. The obvious benefits of being in a position to negotiate bespoke trade deals with our trading partners are taking longer to feed through into the economy, an issue that has been impaired by the current economic downturn.

The MPC agrees with the Governor’s assessment that the country faces a recession that is likely to last for the next four quarters, and it is probable that during the fourth quarter of last year, growth contracted.

Talks were held yesterday between Government Ministers and union representatives of the railway workers, nurses, and teachers to try to find a solution to the current industrial action.

Overall, the mood was one of disappointment when the talks broke up with comments questioning the commitment of the Government to make any compromises, particularly over pay during the current financial year.

The pound remains in the doldrums as it looks for drivers to set the trend for the new year. It rose against a moderately weaker dollar to a high of 1.2198 and closed at 1.2162 in a market which is struggling to shake off a feeling of lethargy.

The Federal Reserve is still making serious efforts to remain hawkish on rising prices, despite the moderating rate of inflation that that has been seen over the past couple of months.

At its last meeting of 2022, the FOMC reduced the size of its hike in interest rates from seventy-five bases points to fifty, although Jerome Powell in his post meeting press conference said that the Central bank remains vigilant over inflation, particularly as there has been no discernible cooling off in the employment market which remains uncommonly strong.

Friday’s release of the December employment report meant that the financial market will continue to expect a further hike in short term interest rates at the meeting that is scheduled to take place on February 1st.

Raphael Bostic, the President of the Atlanta Federal Reserve, was the first cab off the rank in setting his view of the path for interest rates this year.

Having reiterated his belief that the economy is highly unlikely to suffer a recession this year, although he acknowledged that there may be two consecutive quarters of mild contraction, he believes that interest rates will need to remain above 5% for a long time.

He went on to say that 5% is his minimum requirement and wants to see the data for the Holiday period before deciding how he will vote at the next FOMC meeting. That would seem to indicate that the choice is between fifty and seventy-five basis points.

Were the data to drive a belief that a further jumbo rate hike was deemed necessary, there would be a return of the clamour about how the Central Bank is driving the economy into the ground.

As things stand, if the Fed deems it necessary to hike rates by fifty basis points it would send the message to the markets that it expects a soft landing.

There was some sign of moderating wage growth in the data released on Friday and if that moderation continues it is likely that moderation continues the FOMC meeting should be able to comfortably vote for a fifty-point hike.

It is clear that Jerome Powell is determined not to repeat his transitory inflation remarks and while he is exercising caution in believing that inflation is on the right track, he is also aware of the dangers of slowing the economy too abruptly.

The dollar index remains in base building mode. While other G7 Central Banks remain committed to tighter monetary policy, the dollar holds no advantage. In fact, if the Fed makes further dovish comments, the Greenback may have further to fall in its current correction.

Yesterday, it fell to a low of 102.94 and closed at 103.19. The close below 103.40 is a moderately bearish signal, but the current volume of trading is unlikely to build sufficient momentum for a major fall.

Christine Lagarde and her colleagues on the Governing Council of the European Central bank will be wary of reports that there are growing concerns of a possible significant rise in wages across the entire Eurozone.

If that were to happen, the Central Bank would be left with little option to continue to tighten monetary policy.

Given the furore that the previous hike caused amount the more indebted nations, Italy in particular, any thought of a pre-emptive hike in rates is no longer a viable option and the ECB has to remain committed to being data driven.

The issue with that path is two-fold. First, if inflation were to explode higher for any reason, the Central Bank may not be able to act fast enough to get the genie back in the bottle, while it could be accused of the tail wagging the dog, as monetary policy takes on a two-tier pace with the majority of inflation being seen in the newer members of the Eurozone in the old Eastern European and Baltic States.

The calculation of the harmonized index of prices may need to be looked at with a fresh pair of eyes, and it may need to be tweaked to take into account a number of vagaries which sees the individual inflation rates vary enormously.

For example, in Latvia, the latest inflation data shows the headline to be 21.7.1%, while in Spain it is 6.7%. The ECB bases its adjustment to short term rates on the average rate of 11.1% which only applies to Germany, the Netherlands and Austria, who are, curiously, three of the frugal five.

It is hoped that the current disparity in rates of inflation will fade gradually, but to base monetary policy on such a disparate dataset is bordering on the irresponsible.

This has been something of a secret, hidden away in the hope that inflation wouldn’t rise to such levels that are being seen currently. The ECB has a tendency to make hay while the sun shines, but in reality, lurches from crisis to crisis.

The euro is enjoying a period of optimism currently, mainly due to the ECN being in a tightening bias.

It is unlikely that the economic fundamentals of the Eurozone support the single currency regaining its past level of strength.

Yesterday, it rose to a high of 1.0760 and closed at 1.0731. That is its highest close since early June last year.

Have a great day!