12 December 2022: A watershed week in prospect

The purpose of creating the Monetary Policy Committee was to ensure that the widest range of views possible were obtained to make rate changing decisions both considered and realistic.

Over the years that the MPC has been in operation, by and large, it has worked as expected and the balance of members has worked to ensure that monetary policy reflects its mandate.

The majority of the committee are made up of officials from the Bank of England; the Governor and his deputies, and the Chief Economist. Over the years, there has been a balance struck among the external members between hawks and doves.

The meeting being held this week will highlight those different ideals as monetary policy is approaching a level of neutrality that has not been in place for more than a decade as policy has been accommodative since the financial crisis.

Rates have remained at historically low levels, but now for a variety of reasons, some avoidable and some unavoidable, inflation is rising, and the economy is faltering.

Monetary policy has been tightened at every meeting in the past year, but they have been gradual so as not to put excessive downward pressure on demand in the economy, which would affect output.

The Bank will arrive at a crossroads at its meeting to be held this week and the announcement of the change to monetary policy will be announced by Andrew Bailey, the Governor, on Thursday.

Inflation hasn’t yet been brought under control despite eighty consecutive rate increases so, naturally, the hawks are beginning to call for the increments to be increased, just as the doves are facing growing concerns about the weakness of the economy which is predicted to be in recession in the first quarter if it isn’t already.

It was always likely that the discussion about monetary policy would become more urgent as it reached neutrality and the level of restriction saw hikes have a greater effect on economic growth. It is hard to value the effect on inflation and compare it to the effect on demand without seeing it in practice.

Last week, Sterling broke a run of four positive weeks. It fell marginally to a low of 1.2106, but recovered strongly to recover at 1.2257.

This week, apart from the MPC meeting, a slew of output data will be published today, as well as employment data tomorrow and inflation data on Wednesday. Prices are expected to continue to rise, with the headline expected to reach 11.5% as the fall in fuel prices is more than matched to the continued rise in the price of energy and food.

Despite his recent dovish blip, the Federal Reserve Chairman, Jerome Powell remains heavily committed to ensuring that inflation remains on a downward path eventually returning to the Fed’s target of 2%

Since there has been a shift in the global economy following the Pandemic and globalization has become more a case of reliance on performance, as is being seen currently between China and the U.S., there is consideration being given an upwards adjustment to the inflation target.

The target was put in place to provide an anchor for prices and allow the Central Bank to be guided on interest rate policy. It is hardly prudent to adjust the target every time the economy shifts in such a way that the target is broken.

However, when there is a paradigm shift as is being seen currently, the target becomes irrelevant and once the relevant adjustments are made to the economy, the target should be amended to allow the Fed to adjust monetary policy accordingly.

The smart money is predicting a hike of fifty basis points at this week’s meeting of the FOMC, but it is likely that Powell will deliver only a marginally less hawkish statement than has followed recent meetings

He is expected to hint that the size of increases in interest rates may revert to jumbo proportions if there is any sign of inflation regaining momentum.

Any hike in rates will be considered risky by observers who believe that the economy is on the verge of a recession.

Treasury Secretary, Janet Yellen, appearing on TV over the weekend, said that she believes that there are more positive signs for the economy on the horizon, and she is determined that the economy won’t face a recession.

Last week, the dollar index recovered a little poise, bouncing off inflation at 104.10. It closed the week at 104.96.

As well as the FOMC meeting that concludes on Wednesday, data releases include the inflation report tomorrow, the FOMC projections for the economy that will form part of the Chairman’s statement and retail sales on Thursday.

There have been concerns voiced over the past few days that efforts being made to can first the price that the European Union pays Russia for oil and a more general cap on gas prices will bring about financial instability.

The ECB issued a statement last week in which it called for the rules regarding the tempering of the gas price to be redesigned.

The cap aimed at moderating spokes in energy prices which drove inflation to record highs has caused an increase in volatility in the financial markets and raised stress levels considerably.

The view of the ECB and confirmed by its President, Christine Lagarde, is that the role of the Central Bank as arbiter of market stability could be severely undermined by increased volatility in the wholesale gas market as traders try to hedge their exposures using derivative products.

The ECB feels that its role conflicts with the European Commission switching the mechanism on and off, which has recently driven volatility to unprecedented levels.

Russian President Vladimir Putin recently decreed that his country will not enter into any sales agreements with nations who have put a cap on the price it is willing to pay for his country’s oil.

Members of the European Central Bank’s Governing Council have entered the blackout period prior to this week’s meeting, when they are not allowed to comment on either their voting intentions or to speculate on the outcome of the meeting.

Observers expect the Central Bank to hike rates at the meeting this week and to continue to hike at each of the meetings in the first quarter, despite inflation beginning to fall.

More hawkish members of the Governing Council believe that this is more a coincidence than any reaction to tighter monetary policy and are concerned that as winter takes a grip, prices will begin to rise again.

Last week, the euro trod water, falling only marginally as the dollar index began to find a toe-hold. It fell to a low of 1.0443, but rallied to close at 1.0530.

This week there will be significant interest in the ECB meeting as well as releases of data relating to German Inflation, the ZEW economic report, and Eurozone wide industrial Production.

Have a great day!