20 April 2023: Inflation still above double figures

The March inflation report which was published yesterday, surprisingly showed that the fall in prices from the highs seen last October seems to have come to a standstill.

Headline inflation that includes more volatile items like foodstuffs and energy fell by just 0.3% in March to 10.1%, stubbornly remaining in double figures despite most economists view that it would fall to 9.8%

More concerning for the Bank of England was the fact that core inflation, price increases with volatile items stripped out, was unchanged at 6.2%.

This presents a problem for the Monetary Policy Committee that had been expected to halt its run of rate increases at either its next meeting or the one following, with Andrew Bailey to make the announcement at his press conference following the vote.

It is probable that rates will have to rise even further risking the Government’s optimistic view of an economic rebound later this year. One or two more rate increases risk tipping the economy which is in a fragile state into recession. This is a possibility that the Chancellor of the Exchequer dismissed recently.

Although inflation is still high in the Eurozone, it has fallen more rapidly until recently as the ECB’s more aggressive tightening of monetary policy has had an effect. Britain now has the highest rate of inflation in the G7, another reason why its economy is expected to be the worst performing in the developed world.

Food price inflation has been the most significant contributor to price increases since energy prices have stabilized. The price of staples like cheese, eggs and olive oil have risen by between thirty and fifty percent in the past year.

The financial markets have been forced to reconsider their expectations for the path of interest rates in the UK.

While the Bank of England is committed to bringing inflation down it must also consider the effect that higher rates in the short term will have on the borrowing costs of small and medium businesses.

The pound strengthened yesterday as the markets considered the prospect of higher interest rates. It rose to a high versus the dollar of 1.2474 but quickly ran out of steam falling back to close at 1.2439.

Jerome Powell is expected to shift some of the blame for rising prices and a lack of progress in controlling core inflation onto congress. He feels that the support that has been pumped into the economy post-pandemic is still having a significant effect on demand.

The price of new homes has risen over the past few months despite housing permits and housing starts remaining sluggish. This is due to the fact that when owners place existing homes on the market for sale the prices are often inflated because they are feeling prices rise all around them and try to level the playing field by trying to add value to their property.

For this reason buyers, particularly first timers are seeing much better value in new homes, either single family dwellings or multi occupancy apartment blocks.

It seems to have been a long-running saga, but dire warnings about a recession are still being considered. While there may very well be a technical recession later in the year, where there are two consecutive quarters of contraction, any downturn is likely to be offset by inflation returning close to the Federal Reserve’s 2% target.

It is unlikely that any downturn will be either deep or long-lasting as the FOMC is prepared to put measures in place to avoid anything other than a mild contraction.

There has been a cooling off of expectations that Jerome Powell will announce a pause in the tightening of monetary policy following the next meeting when rates are expected to be hiked by twenty-five basis points.

Powell met with the head of China’s Central Bank recently, and in a joint statement they each called for greater cooperation between the world’s two biggest economies.

However, the level of trust between Washington and Beijing has fallen to such a degree that any mutually beneficial agreement is some way off.

The path of the dollar index remains dominated by the prospect of tighter monetary policy in the U.S. Yesterday, it rose to a high of 102.23 and closed at 101.94.

Next week will see the release of the first cut of GDP for the first quarter with a moderate increase over market expectations a possibility.

Christine Lagarde spoke yesterday of her fears that the war in Ukraine has reached a phase of near stalemate with both sides becoming entrenched as the expected Spring offensives have so far failed to materialize.

Both the Ukrainian and Russian sides appear to be prepared for the conflict to go ion for a considerable time, and this will be the worst of all outcomes for the Eurozone.

The Pressure for Brussels to agree to the supply of weapons, especially fighter jets, will increase as President Zelensky seeks to gain an advantage, while Ursula von der Leyen and her colleagues at the European Union try not to be dragged further into the conflict.

Inflation data for March is due to be released later this morning. Both the core and headline figures are expected to be unchanged as price rises, to use Lagarde’s words remain sticky.

It is unlikely that there will be any change to the market’s perception that there will be a further rise of twenty-five basis points in short-term interest rates at the ECB’s next meeting unless there is a rise in inflation.

The market remains infatuated by the relative interest rate differentials between G7 nations which has been a significant driver for more than six months.

The euro has been in a long term increase since fears of a substantial fall below parity with the dollar evaporated and the Fed became marginally less hawkish while the ECB pressed ahead with further major fate rises.

Until this phase ends, more of the same can be expected. It is unlikely that the ECB will halt rate increases until it sees inflation close to its target which is still somewhat vague.

Yesterday the euro lost a little ground against the dollar, falling to a low of 1.0917, but it rebounded well to close at 1.0954.

Have a great day!