29 November 2023: Bailey accused of doom mongering

There is an argument brewing between the Governor of the Bank of England and the Treasury. Andrew Bailey’s comment last week that the potential for growth in the UK economy is at its lowest point during his lifetime was unusually forthright for a man who generally keeps his emotions under close control.

Both the Treasury and the Prime Minister’s office refuted Bailey’s concerns, commenting that in their view the economy has turned a “corner”.

It is tricky to say which view is correct. Clearly, the economy is struggling to find an acceptable level of activity given the burdens placed upon it by changes to both fiscal and monetary policy.

The press has savaged Bailey for his comments that they interpret as an attack on last week’s Budget Statement from Jeremy Hunt, in which he lowered the amount people pay in national insurance contributions and confirmed tax breaks for firms to invest in plant, machinery and tech.

Hunt has been fulsome in his praise for the Central Bank, but Bailey may have been upset that the Government took the credit for the fall in inflation to half the level it was when Rishi Sunak came to power a little over a year ago.

In truth, the Government has truly little to do with the fall in inflation, while rate increases have taken their toll on prices. Neither can take credit for the fall in the wholesale price of foodstuffs, although they are still close to historical highs, while energy costs have fallen throughout the Summer, also providing the Bank of England with encouragement.

Rishi Sunak will have been disappointed with the timing of Bailey’s comments, since he was chairing a summit in London attended by 200 CEOs of major investors in “UK PLC” in which he was extolling the virtues of the Government’s plans for economic growth.

It is true to say that anyone considering making a major investment in the UK, just as Japanese car maker Nissan announced last week, would be “getting in at the right time” provided they are able to take the leap of faith necessary to believe in Sunak and Hunt’s plans.

MPC member David Ramsden was more upbeat than his boss in his summing up of the economy in a speech made yesterday. He feels that the market is in a state of flux where it is expecting rates to be cut far sooner than the Bank expects, but equally, the fact that employment is still stable is a good sign.

Sterling is still on an upwards trajectory and is now in position to challenge medium-term resistance. Yesterday it rose to a high of 1.2715 and closed at 1.2694. There is likely to be reasonably strong interest to sell between 1.2720 and 1.2740 which may restrict its further progress.

Jerome Powell is being supported in his view that no one can be sure that short-term interest rates have peaked, while it is too soon for a cut in rates to be discussed, from his colleagues on the FOMC.

Fed Governor and member of the FOMC, Christopher Waller, spoke yesterday of his belief that rates are at a level where they can bring inflation close to the Fed’s target of 2%.

The fall in inflation over the past few months has been encouraging, but the Central Bank needs to be on its guard and prepared to hike rates again should there be a situation that may lead to demand outstripping demand significantly.

The Fed, in common with other G7 Central Banks, is grappling with interest rates that are either restrictive on demand or on the cusp of arriving at that level.

It is a relatively easy task, when it is clear that official interest rates are either too high to promote a reasonable level of growth in a country’s economy or so low that inflation is potentially getting out of control, a situation that many have experienced since last year, to decide on rate hikes or cuts.

It is when rates are making the equity of risks between inflation and growth hard to balance that they need a greater degree of discussion.

Powell changed his rhetoric last week to say that the current level of interest rates is achieving that balance right now. That should be a level that promotes a soft landing for the economy, but vigilance will be necessary should inflation begin to rise, or activity begin to fall.

In the run-up to the next FOMC meeting, which takes place on December 13th, the Fed will have had sight of both employment and inflation data for November. It is likely that both will moderate slightly, pointing to a soft landing.

However, should there be an unexpected rise in inflation or the headline NFP not be between 100k and 200K new jobs created, the market will be forced to reconsider its view of future interest rate changes.

It is difficult to say exactly why the dollar is losing ground, albeit not by much, daily, recently. Yesterday, the index fell again to a low of 102.61 and closed at 102.74.

There is support on the charts from its current level all the way down to 102.00, so any further losses may well attract buying, although next week will see the market enter “end of year mode” where liquidity will become thinner and traders will have little interest in opening fresh positions.

It is hard to imagine that short term interest rates are currently not at a level that is restricting demand and bringing inflation down, although for some, if not a majority of members of the Governing Council, inflation is still not falling at an acceptable pace.

Joachim Nagel, the President of the Bundesbank, who may be considered a hawk but not to the same degree as his predecessor, spoke yesterday of his view that rates are at their peak or at least very close to that level while ruling out a hard landing for the economy.

His comments are necessarily a little less hawkish than those of, say, the Austrian Central Bank, since his country’s economy is likely already in recession and activity, particularly in the manufacturing sector, is declining rapidly.

He acknowledged that the Eurozone is unlikely to return to an acceptable level of growth before 2025, and that next year will be split into two distinct halves.

In the first half, the emphasis will be on ensuring that inflation is defeated and is on a path to return to the ECB’s target.

Once that has been achieved, the Bank will be able to begin to promote growth by cutting rates, but in a controlled manner which will see inflation remain low.

Nagel, perhaps surprisingly given the state of not only the German economy but the slowdowns being experienced by several other Eurozone members, does not see a hard landing for the Union, in which inflation remains high, and unemployment begins to rise.

ECB President, Christine Lagarde, spoke recently of her belief that unemployment would begin to rise, or at least the pace of job creation would slow.

It seems obvious that job growth will slow given the current level of interest rates, and it is a function of how restrictive rates are whether they “choke off” further growth in the jobs market.

This is an area where fiscal policy needs to be centralized. Individual nations are initiating schemes to promote employment, while monetary union uses interest rates to slow job growth.

The pace of the Euro’s rise has slowed as it approached the 1.10 level, which is seen as critical. Yesterday, it tentatively rose to a high of 1.1009 and closed at 1.0988.

A close above the 1.10 level may see some long-term shorts be squeezed out, but it is hard to give a reason for a continuation of this trend to go on much longer.

Have a great day!