29 March 2023: Investors testing bank’s strength

The Prime Minister spoke yesterday of his confidence that the economy will see a return to a level of growth that is at, or above, trend next year. Rishi Sunak acknowledged that Brexit and the shocks created by the Coronavirus Pandemic had set the country back.

He went on to say that while all developed economies have faced their own unique challenges, the global increase in inflation has been a common theme. He praised the Bank of England for the manner in which it has tightened monetary policy over a period of eighteen months. Raining interest rates at eleven consecutive meetings.

The challenges that Andrew Bailey and his colleagues have faced have underlined the importance of having an independent Central Bank.

Bailey himself and his colleague, Deputy Governor, David Ramsden, testified before the Treasury Select committee yesterday. They were providing MPs with their views on the collapse of the Silicon Valley bank in the United States and any possible effect there may be to the financial markets in the UK and Europe.

Bailey said that the collapse of the band, primarily set up to cater to the financial needs of tech startups, was the fastest seen since the Barings Bank crisis in February 1995. He went on to say that it was unlikely that the issues that led to the sale of Credit Suisse to Union Bank of Switzerland were company specific.

While we are in a period of heightened tension and alertness, the UK financial system is in a totally different place now compared to the financial crisis of 2008. The Bank remains on high alert as investors continue to hunt for points of weakness in the system which could lead to a domino effect.

Ramsden went on to comment that the supervisory team at the Bank are keeping a close watch on UK banks funding costs and so far there is very little evidence of any bank being charged a premium to borrow from the market.

Naturally, the Bank of England stands ready to ensure that banks do not face any issues founding their day-to-day business due to stresses relating to the overall confidence of the market.

Sterling has gained over the past couple of weeks as there has been a decrease in the level of pessimism that surrounded the UK economy. Last week’s Spring Budget gained the approval of the IMF, which commented that the country was on a path to recovery,despite having faced severe headwinds.

Yesterday, Sterling rose to a high of 1,2349 versus the dollar, closing at 1.2342.

While the risks of a hard landing for the economy have fallen over the past few weeks, there are still business leaders and analysts in the Capital markets who believe that once the full effect of the significant tightening of monetary policy that has taken place over the past year has taken its full effect, the economy will face a short sharp recession as unemployment begins to rise.

Workers are still swapping jobs, calm in the knowledge that there are plenty of openings currently that afford them the opportunity to see an often significant salary increase for doing essentially the same job.

It won’t be until workers become more concerned about job security than pay that the significant increases that have been seen in new job creation will begin to abate.

As has been the fashion of late, the markets expect the next Employment Report to be the one that will see the headline figure begin to turn around. Other than last month’s non-farm payroll figure, which would have seen it impossible to match the more than half a million new jobs, the past two quarters have seen a steady increase.

Those who are expecting a turnaround in the employment data are looking to the time when monetary policy becomes restrictive on demand, but it is clear that it will be something of a chicken and egg situation. The fed funds fate may already be restricting demand, but the effect hasn’t fed through yet.

Data for consumer confidence in February was published yesterday. It showed a return to positive numbers after two months of decline. The confidence board reported that it rose from 103.4 to 104.2. While this is a marginal increase, there hasn’t been the significant tailing off that had been expected as a prelude to a slowdown in the economy.

There remains slight concerns over supply chains, but by and large, bottlenecks have faded from the issues that were being seen over the past year.

The Fed is still showing concern over any liquidity crisis that may be seen in the regional banking market. The central bank is not reporting that any banks are struggling for funding currently, but it remains on high alert, ready to pump funds into the market to alleviate any concerns.

The return of risk appetite has a major factor in the direction of the dollar this week,

Yesterday, the dollar index fell to a low of 102.38 and closed at 102.42. It still has some way to travel before it threatens support that is set at around 101.85.

There is a perception pervading the markets at the moment that the ECB is going to remain more hawkish over monetary policy than other G7 Central Banks.

While there is concrete evidence to base this upon, traders and investors believe that both the Federal Reserve and the Bank of England will call a halt to their own programmes of interest rate increase at their next meetings, which take place on May 3rd and 11th respectively.

However, the ECB is expected to continue to hike rates at, at least its next two meetings, although there is expected to be a basic timetable announced for it to gradually dial back hikes at its next meeting.

Inflation in the Eurozone is expected to remain higher than in its competitors, mainly due to the fact that there is no consolidated fiscal policy to aid the Central Bank. It is expected that once all three Central Banks have finished hiking rates that, although the Bank of England was first and the ECB last in the beginning, the overall periods of hike will be very similar in both degree and number.

There is no doubt that the ECB has by far the most hawkish makeup of the three, while both the Federal Reserve and Bank of England are forced to take account of the effect of tighter monetary policy on growth.

The Frugal Five which is currently driving policy in the Eurozone have populations that support higher rates as a way of dealing with inflation., They also appreciate higher rates as they are mostly avid savers.

The expectation of higher interest rates in the Eurozone has lit a fire under the single currency that is unlikely to abate until a further test of the significant rate of 1.10 versus the dollar has been tested.

Many traders feel that if it can break that level significantly, it will, having soaked up all the selling interest taught is set around the 1.10 level, it may set more significant highs with the 1,10 level reverting to support.

Yesterday, the euro made a high of 1.0848, closing at 1.0844. The next minor resistance point is at 1.0920.

Have a great day!