29 August 2023: Inflation is unlikely to encourage the Bank of England

It is expected that inflation will have fallen again when the data for August is published. While that will be welcomed by the Bank of England, it is unlikely to encourage the Monetary Policy Committee to pause the cycle of increases in the base lending rate.

Inflation remains a concern, although the focus of the City of London has switched and despite the welcome news that the IMF does not believe that the country is facing an imminent recession, the feeling “on the ground” is different.

The output data that was released last week showed that the service sector is beginning to slow and can no longer be relied upon to raise the composite figure above the watershed figure of 50 which divides expansion and contraction.

Ben Broadbent, a current member of the MPC and Deputy Governor for Monetary Policy, spoke last week of his expectations, which are also the views of his colleagues, that interest rates are unlikely to begin a downward trajectory for some considerable time.

Naturally, Broadbent was unwilling to be any more specific, but market analysts were happy to “fill in the blanks.”

It is felt that although rates have now entered a restrictive phase, and the Bank of England will be more cautious about further hikes, they are not expected to begin cutting rates until well into the second quarter of 2024.

Broadbent went on to say that inflation will not fall as quickly as it rose since the wholesale price of energy will remain elevated.

Mortgage lenders have been lowering the rates they charge for fixed rate loans recently, but while this makes for welcome headlines, the cuts announced so far have been marginal at best. However, Lenders are more able to offer fixed rate deals now after a turbulent few months.

There is still a possibility that the MPC will vote to pause rate increases when it meets in a little over three weeks’ time. There is a growing belief that fall import costs are taking time to feed through into headline inflation and the MPC may feel able pause for one month. This would show that they are able to be proactive, particularly when it is only relatively recently that they felt the need to hike by fifty basis points.

A lot can happen in three weeks as the market “gets going” again after the summer lull.

Sterling saw little action yesterday given the public holiday while last week, it lost ground, due to the fall services output.

It fell to a low of 1.2548 on the week, closing at 1.2580.

It was expected to provide the market with something tangible to guide it through the current thinking of the FOMC, but in the event, Jerome Powell’s speech at the Jackson Hole symposium provided as many questions as answers.

Powell reiterated that inflation remains high, but failed to be any more specific and he confirmed that the Central bank is committed to seeing it return to the 2% target.

He believes that a continued fall in headline prices will be seen but it will not be linear, and the FOMC is likely to agree that if there are any upticks in the coming months, they may need to react by adding further hikes.

Headline inflation was at 3.2% in July which is higher than had been hoped. The target for the fed funds rate is currently 5.25% to 5.50%, following hikes at eleven of the past twelve meetings.

Powell went on to say that the FOMC is closely monitoring global events like the conflict in Ukraine which led to and continues to see volatility in food and energy prices.

He accepted that the current slowdown in economic activity is most likely due to higher short-term interest rates but does not feel that the economy is any closer to tipping into a recession than it was at the start of the current quarter.

The market has been increasingly positioning itself for further rate hikes but this week’s employment report for August followed by inflation data will be pivotal.

The headline number for new job creation will have fallen again but not by an amount to set off any alarm bells, and it still points to a soft landing for the economy.

Inflation is finding going tough as it moves closer to the Fed’s target. Powell refused to confirm that he believes that rates are restrictive yet, and this led to further speculation that there are still hikes “in the pipeline.”

The dollar index appears to have begun a gradual uptrend. It rose to a high of 104.44 last week and closed at 104.18. This was its sixth consecutive higher weekly close. It may well challenge the resistance between 104.80 and 105.20 if FOMC members make more hawkish comments in the coming weeks.

Her annual holiday has not produced any more mellowness in the President of the ECB. A few days after her return, Christine Lagarde has already returned to making the hawkish comments that were conspicuously absent from her speeches in July.

Having “tested the water” with her colleagues, Lagarde was firm but in a more conciliatory way about the need to continue to tackle inflation which remains too high.

She feels that there has been an economic upheaval over the course of the past twelve months, not as fierce as the events of the past ten years or even the Pandemic, but the tectonic plates of the global economy have shifted and will continue to shift.

Recent events in Russia show that even as sanctions continue to be enforced it is still having a negative impact.

Lagarde also spoke at the Fed’s Jackson Hole Symposium and spoke of the need for Central Bankers to be extremely attentive to the volatility that emanates from wages continually chasing prices.

There remains a tightness in the global economy and if it fails to return to some form of elasticity in the coming months, inflation will continue to be an issue.

She believes that Central Banks in the most advanced economies are at a crucial stage in their monetary policy journeys and must remain both vigilant and prepared for unexpected eventualities.

There is a clear and growing need for monetary policy to be more “calibrated” in order not to cause unnecessary pain to the economy.

Lagarde’s comments still seem to be about the Eurozone economy as a single “animal” while, on the ground, the situation is vastly different. That Germany remains supportive of further policy tightening is just as well since it, and Italy, are already in recession.

Spain and Greece, on the other hand, are performing more than adequately currently. The situation in France remains more fluid but the Government of Emmanual Macron appears to have escaped the worst of the “summer foment” in their country.

The head of the Austrian Central Bank, Robert Holzman remains the “Chief Hawk” position at the ECB. He spoke last week of a rate hike being necessary next month if there are “no surprises.”

The Euro remains under pressure as the Eurozone suffers in comparison to the U.S. Last week, it fell to a low of 1.0765 and closed at 1.0795. Until the ECB announces a pause in its cycle of rate hikes, the currency will receive a modicum of support, but as soon as that is withdrawn, it may fall with considerable speed.

Have a great day!