Cost continues to rise at above expectation

The rise in the cost of living shows no sign of abating as headline inflation hit 7% in March. The cost of fuel was the major factor in the increase, while several foodstuffs linked to Ukraine and Russia also contributed.

Unlike the slowdown seen in the U.S., the rise in core inflation also shows no sign of slowing down.

The rise in the headline figure eclipsed the expectations of analysts, who predicted that the rate would reach 6.7%.

Following the significant increase in household energy bills, inflation is on track to top out at 9% according to global banks Goldman Sachs and J.P. Morgan. That high is expected to be reached either this month or next, although there will be another spike when the energy cap is adjusted again in October.

With the economy slowing as evidenced by data released earlier in the week, stagflation is now being seen as a genuine possibility.

The last time inflation was higher than it is currently was in 1982, during the first Thatcher Government, when it topped out at 10.2%. The hope this time is that prices have been affected by one-off items like the emergence from the Pandemic and the conflict in Ukraine.

It would be glib to label inflation a global issue, despite the fact that both the U.S. and Eurozone are witnessing higher rates of inflation, while sanctions have seen it rise to 2.5% in Russia.

Prices have also risen significantly in the hospitality sector due to their unavailability this time last year, when the country was still gripped by lockdown measures.

The Prime Minister, while staunchly refusing to resign over the Partygate Scandal, is rapidly running out of wiggle room, as it is expected that he is going to receive two more fixed penalty notices. Boris Johnson’s credibility is at an all-time low, likely to be followed by his popularity rating.

The fresh data for March is likely to see the Bank of England be forced to review its latest guidance when it predicted that inflation would reach 8%. The MPC is now facing a close to impossible choice; it will either need to hike more aggressively to stave off inflation, but that will slow output and activity further, while pausing, the current cycle of rate increases risks seeing inflation expectations reach 10%.

The next MPC meeting is on May 5th and will also see the release of the latest monetary policy report.

Yesterday, the pound climbed back above the 1.31 level and now appears to have a short-term bottom in place at 1.3000, where strong support can be expected. It reached a high of 1.3117, closing at 1.3116.

The rise has been attributed to the lack of follow through following a couple of attempts to breach the support. This appears to have been purely a technical move, since the fundamentals still favour the dollar.

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Concern over midterms to drive criticism

As politicians begin to consider their re-election hopes when the midterm elections take place in November, there is a growing fear that a decline in the economy coupled with rising prices is going to be placed firmly on the shoulders of Democrats.

Countering rising inflation remains the most pressing issue for the Federal Reserve, although Jerome Powell needs to be mindful of the effect a swathing cycle of interest rate rises will have on the economy.

While it is still believed that activity remains robust, looking at a three-to-six-month time horizon during which interest rates may double, things may look very different.

Producer Prices, the cost of raw materials and spare parts at the factory gate, an indicator of future consumer price inflation, continue to rise. While there are several other factors that contribute, producer prices make up a significant portion of core inflation.

While profits of energy companies and food outlets have seen a significant increase, the same is not true of the banking sector that has been hit by fears for the economy emanating from the increases in interest rates.

J.P. Morgan saw its first quarter profits slump by 42% as uncertainties caused by the conflict in Ukraine and soaring inflation.

Volatility in equity markets saw takeovers and stock market listings delayed, leading to falls in revenue for banks.

CEO Jamie Dimon spoke yesterday of the need for the Fed to engineer a soft landing for the economy if recession is to be avoided. J.P. Morgan is considered to be something of a bellwether for the sector, and the Q1 results sent something of a shiver through Wall Street.

The prospect of the long weekend cooled interest in any follow through for the dollar index following a close above 100. Yesterday, it fell to a low of 99.82, closing just a single pip from the low.

Next week is likely to be quiet for the dollar as there are no significant data releases.

Traders are likely to gather their thoughts ahead of the approaching FOMC meeting, where a fifty-point rate hike together with further advance guidance on the reduction in the size of the Bank’s balance sheet are expected.

Central bank policy decision statement eagerly awaited

The odds are very much against any change in interest rates at today’s ECB meeting. It is not known whether ECB President Christine Lagarde will join in person, given her recent bout of Coronavirus, but either way, she is likely to face severe pressure to agree to more hawkish policies going forward.

Given that it is still considered the most dovish Central bank in the G7, a major turnaround in outlook is unlikely. While there have been calls for a more hawkish attitude to rising inflation over the past few months, the blow to activity created by the conflict in Ukraine will probably see policy left unchanged, and even a return to more supportive policies.

There is also concern about the fact that Finland and Sweden are both considering joining NATO, with Finland possibly only weeks away from membership.

There has so far been little reaction from Moscow to this possibility, but given that having a NATO member with a direct border was one of the motives cited for the invasion of Ukraine, fears are growing.

The latest report of financial conditions in the Eurozone shows a tightening that is expected to add to a slowdown in economic activity during the second quarter.

This will be an additional factor when the ECB is considering any tightening of monetary policy to combat inflation that is now at 7.5% and rising.

Standards of credit have been tightened by banks. This is an early indicator of fears of further concerns of the financial credibility of several sectors of the economy in a number of Eurozone members. It must be remembered that even prior to the Pandemic, there were fears regarding the weakness of bank balance sheets and the overhang of bad loans from previous crises.

While the stagflation bogeyman hovers over almost the entire developed world, it is most prevalent in the Eurozone, given the proximity of the conflict to several member borders and the reliance of members, not least of all the region’s largest economy, on Russian energy imports.

After Easter, there will be a focus within the market on the French Presidential Election that will take place on April 24th. While the incumbent, Emmanuel Macron leads Marine Le Pen, there are a significant number of voters who are apparently still undecided, and they could easily sway the result.

Yesterday, the euro regained a little composure, but was unable to break back above the 1.09 level versus the dollar. It reached a high of 1.0894, closing at 1.0883.