17 April 2023: Bailey predicts more rate hikes

Bank of England Governor Andrew Bailey speaking at the IMF last Friday, played down the risk of further disruption to the UK banking sector.

Turmoil created by the collapse of two U.S. regional banks and the issues that led to Credit Suisse having to accept a forced takeover by Union Bank of Switzerland, Bailey is fading, and believes that the reforms that have taken place since 2008 have reinforced the sector.

However, he still acknowledged the risk inherent in the overall financial sector due to the growth of non-bank institutions such as hedge funds and pension companies.

He believes that there will need to be fresh legislation brought in by the Financial Conduct Authority and approved by the Government in order to better control their affairs. Bailey acknowledged that this is a difficult path to negotiate since these funds contribute a significant amount to the UK economy in tax.

Last week, Sterling continued its recent rise against a weakening dollar. The overall situation created by G7 Central Banks considering bringing to an end their recent cycles of tiger monetary policy is the overriding driver of the currency market currently.

The Bank of England has been apologetic every time it has hiked interest rates over the past fifteen months despite inflation reaching 11.1% in October 2022.

Although prices have moderated somewhat from their high, Huw Pill, the Bank’s chief economist remains concerned, talking recently about needing to see the job through to the end.

This week sees the release of the March inflation report. It is predicted that the headline will have fallen into single figures, but only just. There remains a small risk that it will be at 10%.

Core inflation is expected to fall to 6% from 6.2% in February. The March jobs report will be published tomorrow. The claimant count is expected to have fallen by a further 11k while average earnings are also expected to continue their recent downwards path.

Sterling reached a high of 1.2546 and closed at 1.2512. This broke a four-week run of higher closes.

Although it believes that it has been as transparent as possible over monetary policy, the Federal Reserve is still delivering significant doubts to the financial markets. There are several analysts and economists intimate that they have a direct line into Jerome Powell’s inner sanctum.

The only issue is that each of them appears to be listening to a different story. In truth, the FOMC will probably deliver a twenty-five basis point increase in the fed funds rate at its next meeting that is scheduled to be held in early May.

Furthermore, Jerome Powell may signal that he and his colleagues have agreed that they will pause rate increases although the use of the word pause, infer that if prices do not fall in accordance with their expectations, there will be no hesitation to hike again.

An internal report from Fed analysts produced for the last FOMC meeting showed that a recession was more likely to happen in light of the turmoil that was taking place at that time in the financial markets.

It is likely that investors and traders took undue note of that rapport given that the turmoil has calmed if not gone away completely. The market will pay specific attention to the minutes of the next meeting that won’t be published until May 24th!.

Treasury Secretary Janet Yellen believes that banks will become more cautious in their lending policies in the coming months as a degree of uncertainty remains. This will yield an unexpected benefit to the Central Bank as it will create an artificial tightening of monetary policy similar to quantitative tightening.

A lot will depend on the April employment report since a similar fall in the headline new jobs created may tip the FOMC over the edge into pausing rate hikes immediately, while an increase in new jobs will likely see the expected scenario take place.

The dollar index remains under pressure from the perception that rate hikes will end imminently. Last week it fell to a low of 100.76 and closed at 101.57, continuing five consecutive weeks of lower closes.

Closing support is at 101.00 and, of course, there will be a degree of strong psychological support at the 100 level.

It seems that Christine Lagarde took Easter off, given the fact that she has been fairly quiet recently. The feeling that there is a growing consensus over a twenty-five point hike at the Governing Council’s next meeting clearly warranted her intervention.

Without mentioning the predicted size of the rate hike, she preferred to discuss the likely path for inflation.

She hedged her bets by commenting that inflation is likely to fall over the rest of the year but considerable uncertainty remains.

Attending the IMF meeting in Washington, he went on to say that both upside and downside concerns remain.

There is concern that the higher than anticipated wage increases that have been agreed recently could see inflation remain elevated, while further financial market tensions or an increase in the rate of energy price falls may slow it further.

She believes that members of the Governing Council need to view the wider picture rather than their own domestic outlook. This was a fairly obvious reference to the comments last week from Robert Holzmann and Pablo Hernández de Cos.

Notwithstanding Lagarde’s efforts to prove a semblance of unity, until there is a unified fiscal policy there will always be disagreement on interest rates.

A classic example of this is the fiscal support Germany provided to its population to cope with high energy prices, yet its representatives remain among the most hawkish on interest rates.

The Euro finally broke above the resistance at 1.10 last week. It reached a high of 1.1075 and closed at 1.0991.

The Bundesbank will publish its monthly report later this morning. It is likely to remain hawkish on inflation, while acknowledging the continued fall of energy prices.

Tomorrow, the influential ZEW institute will issue its report on the economic outlook for both Germany and the wider Eurozone. In keeping with the current rise in confidence, it is expected to show an improvement in economic sentiment.

Have a great day!