8 February 2023: Further rate hikes remain likely

The actions of the Bank of England over the past years or so have been occasionally difficult to understand. The presence of three independent voices on the Monetary Policy Committee means that there are times when policy is driven by a theoretical view of monetary policy which differs from the practicality of dealing with the bank’s mandate to provide a platform for price stability and economic growth.

This has led to Andrew Bailey delivering what have been termed dovish hikes, being almost apologetic for having to tighten monetary policy. The presence of Catherine Mann, Silvana Tenreyro, and Swati Dhingra bring the air of an intellectual discussion to committee meetings, which lessens their impact.

The Comments from Catherine Mann this week added a significantly hawkish voice to the MPC process and being only one of nine voices, her opinions are often far more influential than is actually the case.

The six Bank of England officials who sit on the Committee have both executive responsibility for their roles at the Bank and the task of creating an environment for stability. For example, Bailey and Sir Jon Cunliffe had to calm markets following the potentially disastrous mini budget that followed Liz Truss’ election as Conservative Party leader and Prime Minister.

Looking ahead and past the theoretical views of the independent members of the MPC, it is likely that the Banks will continue to tweak monetary policy at the next two or three meetings rather than decisively creating an environment where inflation is driven lower by interest rates that are actively dampening demand.

This will need to be done against a background of potentially damaging public sector pay awards in order to alleviate the industrial action being taken from a wide variety of workers across the entire sector.

The Prime Minister announced a reshuffle of his Cabinet, providing, in his opinion, a more business oriented face to Minister’s duties, with a view to driving economic activity and growth.

There is little doubt that over the past year, Central banks have re-emerged as a major force in the economy after close to a decade remaining in the background. The return of inflation has necessitated a more dynamic role which, so far, Andrew Bailey has failed to provide. This makes the MPC part of the problem rather than the solution.

Yesterday, Sterling had a relatively volatile day, falling below the 1.20 level against the dollar at one point but also almost touching the 1.21 level. It reached a high of 1.2099 and closed at 1.2039.

Fed Chairman Jerome Powell took part in a Q&A session at the New York Press Club and used language that is alien to most economists. He described falling inflation as disinflation, which is something entirely different and is most commonly seen in the Japanese economy.

Putting terminology aside and interpreting Powell’s words as describing lower inflation, he clearly believes that higher interest rates will be needed going forward, especially with the economy able to create over 500k new jobs in a single month despite interest rates being close to 5%, and having been raised at every meeting since last spring.

He was keen to emphasize the need for patience from the markets and, depending on data, is the most suitable path for the FOMC. He believes that sentiment is important when there is relatively low inflation and the economy is growing close to trend, but data dependence is key to creating monetary policy when the need for tighter policy becomes necessary.

Powell’s colleague and part of the rotation on the FOMC, Neel Kashkari, the President of the Minneapolis Federal Reserve, spoke yesterday of his belief that the strong labour market illustrates the need for the FOMC to continue raising interest rates.

He also feels that although they are approaching 5% there is still room for them to rise further and stay high for longer. He believes that it will be some time until the Central Bank feels sufficiently confident that inflation has been defeated to begin to cut rates.

A fed funds rate of 5.4% remains his target to tame inflation as it was in December, which is above the Fed’s projection which is closer to 5.1%.

He counselled against over-reaction to a single strong employment report which may have contained some technical anomalies, although the trend for new job creation is seeing little effect from higher rates. This is a clue to the fact that rates need to rise further since they are not, as yet, dampening demand sufficiently to see job creation moderate.

The market was a little confused by Powell’s comments, which seemed to be hawkish with a dash of dovishness in that the Fed will raise rates if necessary but sees 2023 as a year of lower inflation.

The dollar index was similarly affected. The index rose close to 104, reaching 103.96, but fell back to close at 103.36 having made a low of 102.99.

The most important task of ECB President Christine Lagarde currently is balancing the polar opposite views of several of her colleagues on the Governing Council.

There are very few marginal doves or hawks represented on the council, they are almost entirely of the view that rates do not need to be raised at all or are in favour of a jumbo hike of seventy-five basis points.

She has had a major breakthrough this week, in that Ignazio Visco, the Governor of the Bank of Italy, commented that he is in support of moderate rate hikes with due caution as long as the implications for the economy are duly considered.

This should be considered a sea change, bearing in mind that Italy had been severely critical of the continuous hiking of rates with little regard for their effect on no just the weaker economies of the Eurozone, but those who do not suffer from either high inflation or inflation paranoia.

Isabel Schnabel, an economist who is the German Representative on the Executive Board of the ECB spoke yesterday of the Central Bank’s intention to hike rates by fifty basis points at its march meeting. This is an unusually direct comment, which, although it mirrors market sentiment, it appears to usurp any voting intentions of Members of the Governing Council.

The President of the Bundesbank was more considered in his comments on the same subject, offering a view that higher interest rates are not yet restricting demand in the region and further hikes may be necessary should the upcoming data support it.

Lagarde also signalled her intention to support a fifty point hike, although she appeared to be considering a pause after that to take stock of the actions taken so far.

This will resonate with the hawkish members of the council, who appear to favour at least two more hikes before a pause.

With the economy beginning to see the light at the end of the tunnel, the tardiness of the Central Bank in beginning its cycle of rate hikes may mean that it does have to continue into late spring or early summer.

The Euro continued its recent correction yesterday, although it was almost unchanged on the day. It fell to a low of 1.0669 but bounced back to close at 1.0725, just four pips lower in the day.

Have a great day!