26 May 2023: Can Sunak trust Bailey to deliver

Andrew Bailey the Governor of the Bank of England has had a difficult time since the Bank began to raise interest, after several years of benign inflation, combat rising prices that, with the benefit of hindsight, bound to rise as the effect of the massive fiscal support throughout the Pandemic, the Russian invasion of Ukraine and rapidly increasing demand had a significant effect on the economy.

Bailey was not alone in being caught off guard, Jerome Powell and Christine Lagarde have also suffered criticism for not taking the threat of rising inflation seriously.

However, Bailey alone has been almost apologetic every time he has announced yet another rate hike, while his G7 colleagues, the Federal Reserve in particular, have been far more dynamic and committed to tighter monetary policy.

The Bank of England started to tighten monetary policy first among G7 nations, using a series of twenty-five basis point hikes, possibly underestimating for a second time the seriousness of the threat that rapidly rising inflation could be to the economy.

While the country’s G7 partners were undertaking fifty and even seventy-five basis point hikes, the Bank of England continued to hike rates by twenty-five points for fear of tipping the economy into a recession.

In Europe, inflation remains a significant issue due in no small part to the way fiscal policy is delivered in the region, while in the U.S. the economy “apparently” teeters on the cusp of a recession, although inflation is slowly decreasing, and the Federal Reserve is close to calling a halt to the cycle of interest rate hikes.

When he came to power, Rishi Sunak made a series of undertakings to the country, one of which was to halve the rate of inflation by the end of the year.

Effectively, he charged Bailey with the task of delivering an inflation rate of 5.4% by Christmas.

Having seen inflation fall, but not by as much as had been hoped by the markets and the Central Bank, when official data was released earlier this week, it has become apparent that Bailey’s “head is on the block” and his past failings are beginning to catch up with him.

Having taken over as Governor in 2020, just as the Pandemic started, Bailey still has five years of his term to serve, but it would not be a surprise if he only served half of that if he fails to deliver for Sunak and his Chancellor, Jeremy Hunt.

The “popular wisdom” was that the Bank would call a halt to tighter monetary policy at its next meeting but the failure of headline inflation to fall by as much as was expected, while the core actually rose, means that rate increases will continue most likely through the summer.

Bailey was again late in considering the effect on core inflation of a growing wage/price spiral, but acknowledging that it is happening does not do anything to stop it from taking place, something that will have been noticed by the Cabinet.

It may be that early next year the Chancellor may be forced to consider a more dynamic Governor, more in the image of Mark Carney, Bailey’s predecessor.

In the meantime, Bailey’s fate appears to be inextricably tied to the fate of inflation, and the clock is ticking.

Yesterday, Sterling continued its tough week so far, falling to a low of 1.2308 and closing at 1.2321.

The U.S. is apparently inching towards the agreement of a deal to end the debt-ceiling crisis. In the best traditions of Hollywood, it is likely that the deal will be struck at the eleventh hour and Congress will be able to give itself a pat on the back with both sides of the aisle claiming victory.

The word is that President Biden and House majority leader Kevin McCarthy are “only” seventy billion dollars apart in reaching an agreement, and that difference of over discretionary funding of individual items.

Seventy billion is a considerable sum in anyone’s language, but when you are deciding an increase in the debt ceiling to more than thirty-four trillion dollars, it may fall into the category of “pocket-change”.

Hopes have been raised that a package of measures may be presented to Congress today to be debated and voted on later tonight.

Jerome Powell has had a similar ride to Andrew Bailey since he became Chairman of the Federal Reserve. He had two significant handicaps when he was appointed. The first is that he is a Republican and was appointed by the Democrat’s nemesis, former President Trump, and second, he comes from outside the world of banking and economics.

He is a lawyer by profession, and it was thought that either Trump would be able to bypass him as he prepared for his second term in office or he would be simply too inexperienced in dealing with the machinations of Wall Street.

When Biden was elected he, virtually alone, supported Powell’s candidacy for a second term in office, against the wishes of his own Party. Although he failed to recognize the severity of the rise in inflation, calling it “transitory”, he has since been steadfast in his desire to tame inflation and is now close to achieving his goal of a “soft landing” for the economy.

During his second term in office, Powell faced the unusual situation of inflation growing almost out of control. While the economy has faltered. This conundrum has been driven by the significant number of new jobs that have been created since the beginning of the year, which have added to inflation.

U.S. workers, rather than strive for better pay, an action that is labelled “un-American”, they prefer to switch jobs often for a better wage.

That pressure is beginning to abate as the headline non-farm payrolls are beginning to show, while weekly jobless claims have begun to rise, averaging well over the 200k mark.

It has become something of a cliche, but the next FOMC meeting may well be the one at which a pause is called to the cycle of hikes. The release of the minutes of the last meeting, which were published earlier this week, show that a united front has been abandoned with several members of the committee leaning towards a pause, and prepared to be convinced by the data.

The dollar index continues to be driven by the fall in risk appetite attributed to the possibility of a default by the Federal Government. Yesterday it rose to a high of 104.31 and closed at 104.22, its highest since March 17th.

The Brexit supporting right-wing newspapers in the UK chose to use the fact that Germany, the great industrial centrepiece of the Eurozone, and long-time driver of the region’s economy, has fallen into a recession, while the UK had it confirmed this week by the IMF that it is unlikely to suffer a similar fate, as justification for the UK’s departure from the European Union.

That somewhat tenuous view, when the comparative performance of the two economies was nowhere near the top of either side’s Brexit agenda, won’t be allowed to get in the way of a bit of jingoistic tub-thumping.

The fact is that the German economy has succumbed to a period of contraction driven by sky-high inflation in the entire region which goes a long way to explaining both its hawkish attitude at meetings of the Governing Council of the ECB and the speech by the Bundesbank President earlier in the week, in which he called for more hikes in interest rates to defeat inflation.

The rise in inflation and its effect on the seemingly indestructible German economy raises the spectre of the hyperinflation suffered by the country following the second world war, and its justifiable pride in how it recovered into an economic powerhouse.

Of course, inflation 2020’s style bears no comparison to the late 1940s but serves as a reminder of what damage high inflation can do to an economy, a point that has been laboured by the German Ministry of Finance over several months.

The German economy contracted by 0.3% in the first quarter contributing to a year-on-year fall of 0.5%. While this is a poor number, just as it would have been in recent years had the economy grown by 0.3%, the fact that it is negative, marks Germany out as the only G7 nation, apart from Japan, which is still considered a “special case”, to fall into recession.

Germany won’t be changing its demand for rates to be increased at the next meeting of the Governing Council since it is well aware that being soft on inflation now will only exacerbate the situation.

The Euro continues to suffer at the hands of a stronger dollar. It fell yesterday to a low of 1.0707 and closed at 1.0725.

Have a great day!