7 March 2023: Rate expectations unclear

Bank of England Governor Andrew Bailey remains unconvincing in his commitment to bring inflation under control, as he appears more concerned to avoid being accused of tipping the country into a recession that may be difficult to escape.

Despite the Central bank having hiked rates at every Monetary Policy Committee meeting since December 2021, Bailey has been lukewarm in his determination, appearing to place more emphasis on avoiding the economy contracting.

With inflation beginning to fall as energy prices, at least, continue to fall, and some stability is being seen at lower levels, Bailey won’t continue to sanction higher short-term rates for a moment longer than is necessary.

He is able to call on the support of his colleague from the Bank at MPC meetings, but the three independent members have very different views on what needs to be done.

Catherine Mann has voted for larger rate increases at the last three meetings, while Silvana Tenreyro believes that economic growth should be more protected by taking a breather and pausing rate hikes.

Swati Dhingra has been more sanguine on the matter, believing that monetary policy should be more flexible and reactive to trends in the economy.

Bailey’s performance as Central Banks have returned to the forefront of the dual fight against rising prices and a slowing economy has been considered lukewarm at best.

His relationship with the City has been negatively contrasted with that of his predecessor Mark Carney, and he is considered more suited to the regulatory role he filled prior to becoming Governor.

While Boris Johnson left well alone during his time as Prime Minister, Rishi Sunak can be expected to adopt a far more hands-on approach during whatever time he has left as Prime Minister.

Another significant improvement in output was seen yesterday as the PMI for construction activity in February was published. Having remained in contraction for several months, the construction sector saw significant growth last month, rising to 54.6 following a reading of 48.4 in January.

Sterling remains under pressure close to the 1.2050 level versus the dollar as the market remains unconvinced by the next move in interest rates. Yesterday it fell to a low of 1.1993 and closed at 1.2018.

Today sees the release of the Halifax House Price Index, which is expected to be flat after a 0.4% rise in January. This will continue the weakness seen in the housing market as interest rates reach close to restrictive territory.

Fed Chairman Jerome Powell will testify before Congress today, providing a broad overview of the economy and monetary policy. His remarks will be published in advance, but it will be when he is questioned on his performance that he will be pressured to provide what he believes will be the Central Bank’s next major policy decision.

Senator Elizabeth Warren, one of Powell’s fiercest critics, will want to know why the Central bank continues to flirt with a recession despite the fact that inflation has fallen for three months in a row.

She feels that the regional discrepancies in output and productivity show that there is a significant risk that several states could be in recession without the entire country feeling the effect.

That has been the most significant takeaway from the release of the minutes of the latest FOMC meeting, at which Powell was clearly outvoted in his desire to continue with fifty basis point rate increases.

Following the resignation of Lael Brainard as Powell’s Deputy, although she remains the favourite to replace him when his term in office comes to an end, Warren has called for the appointment of a strong character as her replacement, who is able to stand up to Powell’s overtly hawkish tendencies and restore a more growth oriented outlook.

Brainard’s favouritism for the appointment as Chairman obviously depends on the result of the 2024 Presidential Election. She would be the first Democrat since William Miller who served under Jimmy Carter to become chairman, although Janet Yellen, who was unceremoniously dumped by Donald Trump, thought to be a Democrat.

This week’s employment report will go a long way to determining the outcome of the next FOMC meeting, and it will be interesting how Powell contrasts the smaller rate increase agreed at the previous meeting with the significant increase in the number of new jobs created by the economy in January.

The dollar index threatened its short term trend low yesterday as investors adopted neutral positions ahead of Powell’s testimony. It fell to a low of 104.16, closing at 104.26. There is significant support at 103.80, but it will take a significant volte-face from Powell to see that tested.

Data released yesterday for retail sales in the Eurozone illustrated how much further the entire economy has to travel before it can be considered to be out of the woods, and considered safe from a recession.

The data for retail sales is a kind of distillation of the entire economy which encapsulates confidence, employment, economic outlook and a wide range of political and social issues.

Consumers have been and remain chastened by rising energy costs, while the war in Ukraine has the potential to spill over into a far wider conflict.

With interest rates now expected to rise until at least the summer, with the ECB seemingly determined for them to reach a level that restricts demand, there is a distinct lack of confidence that the improvement in the outlook is anything more than a blip.

It had been expected that the Sentix Index of Investor would see some improvement from the -8 reading for January, but its release yesterday showed that confidence sagged further, falling to -11.

With high inflation continuing to exercise, the more hawkish members of the ECB Governing Council, and Christine Lagarde believing that Government energy subsidies are, at least part, of the issue consumers are continuing to face tough times.

Retail sales, which contracted by 2.8% year-on-year in January, fell by marginally less in February, although the month-on-month figure was also negative.

Philip Lane, the ECB’s Chief Economist and former Governor of the Bank of Ireland, gave a more hawkish speech yesterday than he has delivered recently. While acknowledging that a rate rise later this month is all but certain, he went on to say that he expected a further increase in May, while it is too soon to rule out another hike in June.

Lane has often kept his own opinions close to his chest, while supporting the general view of the Governing Council. It is difficult to say if he was merely echoing Christine Lagarde’s views or if he feels there is a genuine need, across the entire Eurozone, for higher rates.

The euro rallied to test the top of its recent range following Lane’s remarks. It rose to 1.0694 and closed at 1.0474.

Have a great day!