Low rates preceded Covid-19 in unfathomable generosity

Renowned economist Jim O’Neill spoke last week of his confusion over the path of inflation in the UK. It is simply unclear whether inflation in the UK is temporary or not.

This means that predicting how the Bank of England will manage monetary policy in 2022 is impossible to predict.

O’Neill believes that the era of loose monetary policy that actually preceded the Coronavirus Pandemic has run its course and the time is fast approaching when it needs to be tightened up.

The pace of the recovery in many developed nations, coupled with supply chain shocks, has led to the current inflationary spike, but the generosity of Central banks is no longer applicable.

There is no sign of any concerted cooperation with G20 to ensure that the global economy emerges from the pandemic able to promote activity elsewhere. This was a feature of the policies adopted in the period from 2008-2010.

Andrew Bailey, the Governor of the Bank of England has acknowledged that with inflation now constantly running above the Government’s target of 2%, that action may be necessary, but he also wants to see further post-furlough employment data before making a final decision.

It is difficult to gauge how the market will react should the Monetary Policy Committee decide against a rate hike at this week’s meeting.

The Employment data for November will be released tomorrow, with inflation numbers due on Wednesday. The Committee members will have been given advance guidance of what the reports will contain, so should be sufficiently armed with the latest information to enable them to make a rational decision.

The 7-2 vote in favour of leaving rates unchanged could still be repeated, especially in the wake of last evening’s televised broadcast from the Prime Minister.

Boris Johnson announced that the risk level from Coronavirus has been raised to its second-highest level by the four home country’s Chief Medical Officers. He went on to say that the target for everyone who wants a booster jab should be able to receive it by the end of the month. This is a month sooner than the original target.

Last week, Sterling sunk to its lowest level in a year versus the dollar but recovered to end a shade higher on the week. It fell to 1.3160 but recovered to close at 1.3257.

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Inflation data shows YoY increases at 6.8% from 6.2% in Oct

The FOMC is likely to turn extra hawkish at its meeting later this week.

The pace of the withdrawal of support for the economy through purchases of Government securities and mortgage-backed securities is set to double to ensure that the bloating of the Fed’s balance sheet ends.

This will enable Jerome Powell and his colleagues to decide on raising interest rates sooner than had been expected as the recovery began and the rise in inflation remained within acceptable bounds.

It is hard to say following last week’s data showing that inflation fell from 0.9% to 0.8% in November that it is beginning to fall naturally.

Year-on-year, headline inflation still rose from 6.2% to 6.8% although with volatile elements stripped out, the rise was less dramatic. Ex-food and energy prices rose from 4.6% to 4.9%. This was what the market had predicted, although it is still well above the official target of 2%.

Despite inflation being far too high, and Jerome Powell having retired the term transitory, it is considered likely that the current level should be close to being as bad as it gets.

Powell and Treasury Secretary Janet Yellen have both spoken recently of the FOMC wanting to be as agile as possible going forward, and an acceleration of the withdrawal of support should allow the Central Bank to be nimbler in its actions.

While the acceleration of withdrawal of support is wholly priced into the current level of the dollar index, it remains to be seen how hawkish Powell is prepared to be given the dampening effect his words will have on equity markets.

Also set to be released on Wednesday of this week are the economic reports from FOMC members that detail the conditions in the various regions of the country that are represented in the current members of the Committee, and their predictions for Q1’ 22.

Last week the dollar index, while well-supported, constantly ran into resistance on approach to the 96.50/60 area.

It reached a high of 96.59 but fell back to close at 96.04.

Support for weaker economies to continue

The fate of the euro in the first half of 2022 is expected to be sealed at this week’s ECB meeting, with Christine Lagarde expected to win the day by battling to continue to provide support for the economy following the expiry of the current agreement in March of next year.

It is believed that the ECB will continue to but between forty billion and sixty billion euros of Eurozone members Government Debt.

With the FOMC and Bank of England both expected to tighten monetary policy by both word and deed this week, further dovish comments will confirm the divergence of monetary policy between three significant members of the G7. This will set the single currency on a path to challenge the 1.10 level versus the dollar, and well beyond that point.

It is impossible to say just how poorly the Eurozone economy would be performing without the significant level of support it is receiving, and it may be a considerable time before Lagarde believes the crisis is at an end and a normalization of monetary policy can begin.

There is no sign, despite civil unrest, of the current round of lockdowns lifting. It is expected that there will be some concessions made, as were seen in 2020 for the Holiday Season, but the first month of the New Year is expected to see the restrictions tightened further.

With infections of the new Omicron variant doubling every two or three days, the economy is likely to suffer further as the European Commission, still congratulating itself over the success of its vaccine rollout, realizes that more drastic action to drive booster doses of the jab is becoming vital.

The euro is likely to test its pre-Omicron low of 1.1186 versus the dollar even before the various Central Bank meetings, as sentiment as well as expectations over the divergence of monetary policy conspire against it.

Last week, the euro managed to rise to a high of 1.1354 as the dollar saw a mild correction. It closed the week at 1.1317, the identical level to its close the previous week.