18 May 2023: More hikes in the pipeline if inflation becomes embedded

Andrew Bailey spoke yesterday of his concerns that inflation is becoming embedded in the economy since the core is not falling as expected following eighteen months of rate increases.

While the markets continue to speculate about when the Bank will pause the cycle of hikes, Bailey confirmed that it will continue to hike rates until inflation falls to its two per cent target.

Bailey talked of his concern over two specific issues; the continued rise of food price inflation, which remains close to twenty per cent, and the tightness of the labour market, although the latest employment report showed that that pressure eased very slightly last month.

He assured his audience of Chambers of Conference members that the Bank will continue to hike rates until the medium-term outlook is in line with the Bank’s remit.

There were signs in the latest employment report that despite unemployment remaining at historic lows, it is slowly beginning to rise. In the first three months of the year, the unemployment rate surprisingly ticked up to 3.9%, despite evidence that more workers are returning following extended absences due to long covid.

Bailey commented that the easing of tightness is not happening as fast as he and his colleagues on the MPC were expecting.

Bailey went on to assert that there are good reasons to expect inflation to fall considerably over the next two quarters. One reason is that the wholesale cost of energy is falling significantly.

The main concern, however, is the possible presence of a wage/price spiral in which wages increase in reaction to rises in the cost of living and firms increase their prices to cover their increased costs which leads to further wage demands.

He said that the Central Bank is keeping a close eye on wage settlements in order to be able to act conclusively if evidence of a spiral emerges.

Sterling has remained in a tight range given the lack of new factors to drive traders into taking new positions. Yesterday, it fell marginally versus the dollar to a low of 1.2486 and closed close to that level.

A new survey released yesterday, which models the effect of several inputs, predicted that the economy is ninety-nine per cent certain to face a recession this year.

Unfortunately, the data fails to predict the depth of the recession or how long it will last.

The FOMC would possibly accept a shallow recession which only lasts two quarters if it is seen as beneficial in bringing inflation back into line.

Since the last rate-setting meeting, the members of the FOMC have put forward radically different cases for how they will vote when they meet again in the middle of next month.

To some extent, the differing opinions are regionally based, while in general, they agree on the economic picture of the entire economy.

Raphael Bostic, President of the Atlanta Fed sees reasons developing for a pause in rate increases, while his colleague from Richmond, Tom Barkin paints a far more hawkish picture.

The major financial institutions still see a recession coming, most likely in the fourth quarter of this year, although they do believe that the Fed is craving conditions that will cause the economy to contract.

In the survey, many economists use more esoteric measures, working back to see what conditions were in place when the economy faced previous recessions. Those who don’t see a recession being anything other than technical, point to the fact that the economy is a totally different animal to what it was four or five decades ago.

The drivers of growth and contraction have been created by one-off “shocks” in the past ten years or so and Governments and Central Banks globally are more attuned to what is happening in a far more “joined up” global economy.

The U.S. has less influence over global events or at least other nations, for example, China, has grown its influence to match what is happening in the U.S.

Yesterday the dollar index rallied significantly, testing the upper limit of its recent trend. It rose to a high of 103.11 and closed at 102.88.

The overall level of property investment in the Eurozone as a whole has fallen rapidly since the start of the year, and most analysts are putting this down to the significant rise in interest rates.

It is no longer viable to buy parcels of land in the centres of major cities from Paris to Vilnius or Helsinki to Lisbon and simply hold onto them as prices rise.

Property either for investment or contracting purposes is a major part of the overall eurozone economy only bettered for its contribution to GDP by manufacturing, so it may be that the Central Bank will be wary about the popular belief that they will hike twice more before any pause.

Gabriel Makhlouf, the Governor of the Bank of Ireland and a member of the Governing Council of the ECB, spoke yesterday of his view that Central banks have lost a degree of the trust of the wider population by only expanding their fate setting decisions to the fairly narrow financial community.

The “ man in the street” deserves an explanation as to why when he sees his monthly food bill rise every month and energy prices doubling and tripling, why the Central bank is also increasing his debt burden by hiking interest rates.

There is an obligation for Central Bankers to explain themselves and why they don’t expect inflation to be back averaging two per cent before 2025.

Having faced rising inflation for more than a year, there is a real possibility that several members of the Eurozone will see a recession later in the year unless the ECB pauses its schedule of fate hikes soon.

Makhlouf was in conversation with Loretta Mester, the President of the Cleveland Fed at a round table conference.

Mester agreed with the central theme of openness, since in the U.S. everyone is expected to be a “financial engineer” or simply go along with the decisions of Central Banks.

The Euro continues to correct and fell to a low of 1.0813 and closed at 1.0840. It is in danger of the current correction becoming a trend as it reaches the lower end of its current range.

Have a great day!