Brexit exodus, a factor in higher wages

The UK continues to struggle to find workers to fill roles in the hospitality sector as the exodus of EU workers created by Brexit hits home.

With British workers content to move on to better paid roles with less onerous hours, there is a danger that rising inflation will contribute to higher wage demands in what could become a vicious circle.

It is some time since pay negotiations particularly in the Public Sector were a significant factor but as the recovery takes hold whether the 21st of June reopening happens or is delayed for a few weeks, longer term the country could become a victim of its own success.

The UK Chambers of Commerce, in a report published yesterday, forecast full year 2021 GDP to reach 6.8%, although this is dependent upon Boris Johnson’s Roadmap being fully complied with.

This weekend the G7 will meet in Cornwall, with the early arrival of President Biden providing Johnson with several photo opportunities.

Johnson described Biden as a breath of fresh air. Biden may also need to bare his teeth over the continued wrangling between London and Brussels over trade flowing through Northern Ireland. This may carry a threat to the Good Friday Agreement between the Unionist North and Republican South.

There has been a growing divide in the contribution services make to the UK economy compared to manufacturing, with the country becoming something of a niche producer.

Despite this, the report mentioned above puts manufacturing growth at 8.5% with services a little lower at 6.3%. Services account for close to 80% of UK GDP, although manufacturing output mainly in the spare part sector retains a growing reputation for high quality.

Next week, the UK’s employment report for May will be delivered. Although this doesn’t produce the fireworks associated with the NFP, next week’s numbers may see a slight increase in the overall employment rate from 4.8% to 4.9%. This is part of the entire change the economy is going through, and it is unlikely that overall, it will fall much further.

Sterling continues to be in a reactive phase. Versus the dollar, it fell to a low of 1.4073yesterday but recovered to close at 1.4176 close to its high for the day.

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Core inflation at highest since 1992!

This day has been on its way for some time. Headline inflation in the U.S. in May rose to 5% with the core data which strips out volatile items rising to its highest level since 1992.

While Jerome Powell’s chickens haven’t exactly come home to roost, this issue may have arrived sooner than Powell had hoped or expected.

There is clearly a difference of perception when studying the data, a simple, wow, U.S. inflation is at 5% headline barely tells the full story, although it certainly provides a colourful narrative.

That having been said, the financial markets will often deal in perception or knee-jerk reactions that a more considered Central Bank will take in its stride.

The FOMC can hardly be accused of being caught unawares by the data, since it has not been in the business of predicting how far inflation will rise. Neither has it acknowledged how quickly the increase would arrive.

The reaction to the arrival of what the Fed considered to be barbarians at the gate was fully expected. Now, since it has arrived, Powell will face pressure to provide more precise advance guidance.

Powell will probably take a “what did you expect” line when dealing with questions about how much further inflation can rise. The unprecedented support and stimulus provided to the economy had to show up somewhere.

Given the discussions taking place between the President and Congress over further investment in infrastructure projects and the gung-ho approach of Treasury Secretary Janet Yellen, the term transitory may be applied to the rise in inflation but like a hard winter, it may hang about longer than expected.

The market’s attention will now switch to the June FOMC which takes place next week. This meeting is also scheduled to include the publication of the Fed’s quarterly economic projections, which will make interesting reading.

The dollar index reacted sharply to the data, initially rising to a high of 90.31 but eventually fell back as traders realised there is still a fair amount of water to flow under the bridge before the Fed acts. The index closed at 89.98, marginally lower on the day.

ECB sees brighter future and short-term inflation pressure

Yesterday’s ECB meeting did very little to provide either solid evidence or a timetable to the market for when the Central Bank will act or even provide a hint of advance guidance.

However, perception kicked in again with the quarterly economic projections being healthier than they have been for some time, although Christine Lagarde continued the mantra that it is not yet time for the PEPP support to be tapered.

In the Eurozone, everything is on the rise, confidence, output, growth expectations, and, of course, inflation.

The market has found a new word to play with, it is now inflation this and inflation that. This has replaced Brexit, Pandemic and even recovery on every trader’s lips.

It is rumoured that three members of the Governing Council voted in favour of slowing down the PEPP. While the names weren’t readily available, it was a case of perm any three from five.

If this is true, and the pace of the recovery continues to gather pace, particularly as the rate of vaccinations reaches capacity, the perception may morph into a reality Lagarde may find tough to contemplate.

Lagarde’s home nation, France, has, as has been said before, switched, as far as its economy, (and possibly its politics) are concerned. From being in favour of a moderate pace of bond purchases, it now voraciously accepts support as its debt pile grows.

Undermining ECB policy are two significant issues that simply will not go away on their own. First, the bad debt portfolio which affects just about every bank in the Union will need to be addressed, and the possibility of a bad bank will return.

The other issue will be the level of the overall debt to GDP ratio of the entire Union, which will be a drag on the recovery that could stretch into years.

The euro also saw a reaction to the U.S. inflation data. It fell to a low of 1.2143 gradually climbing back to close at 1.2173.