11 July 2023: Mann believes that inflation has become embedded in the UK economy

Catherine Mann is the most hawkish of the independent members of the MPC. She has been voicing her concerns about the effect of high inflation on the economy for some time and voted for the fifty-basis point hike in interest rates at the most recent meeting of the rate-setting committee.

In a recent speech, she spoke of her belief that inflation is becoming embedded in the economy and very soon the Bank of England will be powerless to eradicate it using “conventional” methods.

She agrees with the Governor that there is unambiguous evidence that firms are using the current crisis to maintain, and in some cases, increase their margins. She believes such practices are a prime cause of how inflation will become a “fact of life” again, and must be dealt with as a matter of priority,

It is easy to see obvious examples, like the forecourt price of fuel, but beneath the surface, the practice is becoming so widespread that it is becoming easier to name the sectors of the economy where it is not happening.

Last week the Treasury sold £4bn in Government debt at a price that equated to 5.6% per annum. That is higher than the cost at the height of the Liz Truss inspired crisis that threatened to swamp the economy last Autumn.

The current state of the UK is confounding experts as the Central Bank is doing all the things that it should to bring inflation down, but the headline remains the highest in the G7 and the UK is the only developed nation in which inflation is still rising.

There are serious doubts being voiced about the Prime Minister’s pledge to halve the rate of inflation by the end of the year.

One of the reasons that inflation is still so high is the rise in wages that have been seen over the past six months in the private sector. While they are overshadowed by the almost “traditional” militancy of the public sector.

The Private sector has been affected by the lack of workers, both skilled and unskilled, that Brexit has created. This is particularly prevalent in two principal areas. There is a significant shortage of skilled tradespeople in the construction sector, which has driven costs up, while unskilled labour has been in high demand in the agricultural sector and will only get worse as the harvesting of home-grown fruit and vegetables reaches its peak.

Rishi Sunak is under pressure to loosen the visa regulations that have been in place since Brexit was finally agreed, while he is facing demands to get an agreement with the EU to have “Swiss style” access to the single market.

Today will see the publication of the June employment report. It is expected that the headline new claimant count will continue to fall, putting further upward pressure on wages.

Later in the week, month-on-month data for GDP will be released, and this is expected to show that the economy contracted by 0.4% in May, increasing the possibility that the economy is heading for a period of stagflation.

The pound rallied further yesterday, as the dollar reacted to the likelihood that inflation has continued to fall in the U.S. It broke above resistance at 1.2840, reaching a high of 1.2868 and closed at 1.2861.

In his recent testimony to Congress about the state of the economy, Fed Chair, Jerome Powell was forced to admit that he was “blindsided” by the impact of the Fed’s reduction in the size of its balance sheet.

“Quantitative tightening”, as it has come to be known, where a Central Bank reduces the size of its balance sheet by withdrawing liquidity from the market at the same time as raising interest rates, is both complex and hard to predict.

The Fed is still shedding its bond holdings at a rate of approximately one trillion dollars a year, and it is unclear just how much tightening that will add to the continued cycle of interest rate hikes that are currently taking place despite the well-publicized pause that took place last month.

Tomorrow will see the release of the June inflation report, and the market is expecting another significant fall in the headline rate as well as a drop in the core rate.

Headline inflation is expected to have fallen to 3.1% from the 4% reported in May, while core inflation, which has the more volatile items stripped away, fell to 5% from 5.3% previously.

Several members of the FOMC have already confirmed that they will vote for a further hike in rates at the next rate-setting meeting, and yesterday, the President of the Cleveland Fed, Loretta Meister, joined their ranks.

She spoke of her view that there are still strong underlying pressures on inflation that are not obvious at first glance. The economy has shown greater strength recently than it was earlier in the year when speculation of when the Fed would end the cycle of rates was at its highest, and predictions of a coming recession were growing.

She feels that to drive inflation back to its 2% target and for it to remain there, two or even three further hikes will be necessary. The FOMC wants to keep inflation at 2%, and there will be no cut in interest rates for some time, possibly not before the second quarter of 2024.

The dollar index is still reacting to last month’s pause in rate hikes and the possibility, however remote, that it will happen again this month.

Yesterday, it fell to a low of 101.95, closing at that level. If this is to be considered the start of further dollar weakness, it will need to fall below 101.20 on the weekly chart to confirm the trend.

Data published yesterday showed that the Sentix index of investor confidence fell to its lowest level for eight months in June as concerns over ECB policy causing a recession grew.

The most hawkish members of the Governing Council are ignoring the risk of a prolonged contraction of the economy.

This appears like “payback” for the extended period when they were expected to provide a high degree of support for the weaker economies in the Union, to the detriment of their own citizens who saw their savings and pension pots denuded by exceptionally low-interest rates.

Overall there have been positive results for the economies of Southern Europe, where there has been plenty of relief at the return of tourist members of pre-Pandemic numbers, but underlying that the Central Bank Governors of Italy and Spain, supported by Portugal and Greece, are now showing concern that rate hikes will go on significantly pat the summer.

There has been growing support for the plan being promoted by the Banca d’Italia in which the “doves” would support rates remaining at their current raised level in exchange for an end to further hikes.

That idea is not gaining any traction in Frankfurt, where Christine Lagarde and Joachim Nagel have both thrown their not inconsiderable weight behind hikes in July and September.

The German Chancellor has also shown his support for ECB actions, while the “man on the street” in Germany is supportive of higher interest rates if they are seen to be bringing inflation down.

The Sentix investor confidence index fell to -22.5 this month, down from -17 in June, as investors continue to show concern about the longer-term effect of both rate increases and rates remaining high for an extended period and topping the economy into a long winter of contraction.

Both the current situation and expectations measures fell to their lowest levels since last November.

The Euro continued to be supported by the prospect of higher interest rates, while the prospect of a long-drawn-out downturn is being ignored.

The common currency rose to a high of 1.0973 and closed at 1.0973. The significant selling interest remains between 1.10 and 1.1040. It is possible that it will be able to gather sufficient steam to break through that level conclusively, but a lot will depend on the price action over the next 36 hours.

Have a great day!