30 May 2023: A recession is still possible in 2024

High inflation is going to remain a global economic factor for at least the rest of 2023 and possibly well into next year as Central Banks review plans to begin to pause the cycle of rate hikes.

Inflation has fallen but not as fast as global bodies like the World Bank and the IMF had expected, and it is likely that they will have to again revise their predictions for the major, as well as developing economies.

Although the ECB remains committed to defeating inflation by a seemingly continuous cycle of rate hikes, both the Federal Reserve and the Bank of England had been considering a pause perhaps starting at their June meetings.

Although headline inflation has fallen back into single figures in the United Kingdom according to the data for April, it has not fallen as quickly as had been expected, due mainly to continuing price rises in basic foodstuffs.

Core inflation has become stuck at between 6% and 7% having risen from 6.2% to 6.8% last month.

The Governor of the Bank of England last week admitted his concerns that a wage/price spiral has begun, in which “legacy” wage increases will see the core rate of inflation continue to rise as there is always a lag between the rate of inflation and pay settlements.

Several former members of the Monetary Policy Committee spoke last week of their concern that the base rate of interest rate could have to rise to 6% in order to contain inflation.

If that happens, a recession in 2024 becomes a serious possibility. Although Jeremy Hunt has been encouraged not to cut taxes this year by the IMF, next year may be a different story, where he is forced to cut both personal taxation and stamp duty on property purchases in order to drive the economy forward.

The MPC meets on June 22, and the May inflation data will have been made available by then. If it falls but by less than expected and the core remains above 6.5% or rises again, the Bank would appear foolish not to continue its pattern of rate increases.

Sterling continues to be supported by expectations of tighter monetary policy. Last week it fell back a little as the dollar was supported by concerns over the debt ceiling crisis, while yesterday in a holiday affected session it was virtually unchanged. It opened and closed at the same level 1.2347.

Although the Federal Reserve will be cognisant of the pace that inflation is falling both at home and in other developed economies, the dynamics of the U.S. economy where job creation has been slowed by the cycle of interest rate hikes undertaken by the Central Bank since Spring of last year, there is a growing belief among members of the FOMC that a pause, but not an end, to tighter monetary policy should take place at the next FOMC meeting which takes place on 13/14 June.

Even Jerome Powell who is possibly the most hawkish member of the committee has spoken recently of the possibility of a pause.

It appears that inflation and, indeed economic activity, in the U.S. has become regionalized which has led members of the FOMC to have differing openings on the most prudent course of action.

Now that President Biden and House Speaker Kevin McCarthy have come to an agreement on raising the debt ceiling the “nuts and bolts” of what has been agreed now needs formal approval of Congress.

It would be highly unusual, and possibly catastrophic for the deal to be voted down, but the exercise is more than a “rubber stamp”. Congress will want to be seen as serious about the items that particularly concern both sides of the aisle.

In short, the Democrats want more Federal aid for families, while the Republicans want cuts in public spending.

It is likely that members of Congress will “jawbone” until the eleventh hour, to add a sense of drama to the occasion, but to all intents and purposes the crisis has been averted.

The dollar, which was supported by a fall in risk appetite, is now drawing support from the fact that the country won’t be defaulting on its debt this time around.

It is hard to take the entire process seriously when everyone is aware of what will happen if the “nuclear button” is pressed.

The index reached a high of 104.41 last week and stayed around that level yesterday.

At the end of this week, the May employment report. Most commentators see a further fall in the headline new jobs figure. That will further encourage the FOMC to pause a hike at the month’s meeting.

For what it’s worth, the latest prediction is for 195k new jobs to have been created, down from 253k in April.

The ECB’s Chief Economist, former Governor of the Bank of Ireland, Philip Lane is remarkably at ease over the rise in wages in the European Union as a whole.

He spoke last week of his belief that rapid wage growth is not putting undue upwards pressure on inflation. Some members of the Governing Council of the ECB believe that inflation is possibly going to become “stuck” above the Central Bank’s target of an average of 2%, although Lane says he is well aware of the risk and it is “factored in” to his calculations.

It is doubtful that Lane’s “awareness” of the potential issue will provide much comfort to the more hawkish members of the Council.

They are certain to hike again at the ECB’s next meeting and fairly sure to hike at the one after that. Only then will they feel sufficiently encouraged to discuss a pause in the cycle of hikes.

Lane is pinning his hopes for a drop in inflation upon the continued fall in the cost of energy which, he says, feeds into all aspects of the economy. While that is true he is in danger of ignoring the “stickiness” of core inflation and the lag between falling inflation and higher-than-average wage increases.

An opposite view was presented by Klaas Knot, the Governor of the Dutch Central Bank and a fully paid-up member of the Frugal Five.

He sees core inflation as the ECB’s main concern now, as the energy price fall is being reflected in headline inflation.

He sees core inflation not abating as much as he would like, particularly in the services sector. His newest colleague, Croatia’s Central bank Governor, Boris Vujcic, echoed Knots’ concerns.

The fact that Germany has slipped into recession has been taken in its stride by the ECB since it was fully expected.

The fact that it is not a concern because it was expected appears to be a little naive. Germany is by far the most important economy in the EU and its driving force. It is doubtful that its economic contraction can fail to have a significant effect on the economies of the rest of the group.

Meanwhile, the single currency continues to suffer since its failed attack on the 1.10 level versus the dollar. Since touching that level, it has seen four consecutive weaker weekly closes, the latest being 1.0724 seen on Friday.

There is a degree of optimism from analysts currently that sees the single currency challenging 1.20 versus the dollar when their monetary policies begin to diverge. That may happen in June, but there is no certainty about a Fed pause.

Have a great day!