Jobs data likely to encourage confidence

The UK economy grew at 7.5% in 2021. This was the fastest rate recorded by any G7 member. However, having contracted at the fastest rate in the G7 the year before, this was to be expected.

Overall, taking the net of the two years, the UK placed fourth, having only just managed to return to the level it was at prior to the Pandemic.

Chancellor Rishi Sunak rejoiced in the pace of growth, while playing down the significant headwinds that the economy is facing.

April is beginning to loom large. It is the month that will see the implementation of the Government’s increase in National Insurance contributions. The Government’s cap in energy bills will also be increased. This means that even without rising inflation, household incomes are about to take a major hit.

The knock-on effect of this is that consumer spending will begin to fall as families make a decision that could be as stark as having to decide whether to eat or stay warm.

This week, data for inflation will be released on Wednesday. It is expected that the headline rate of inflation will have risen from 5.4% in December to 5.7% in January. The core figure with more volatile items stripped out is likely to have increased from 4.2% to 4.5%.

The only positive takeaway from this is that the core rate is beginning to rise at a slower pace than had been seen in previous months.

Employment data for January will be published tomorrow. The claimant count is expected to have fallen by around 40k, although the unemployment rate is expected to be unchanged at 4.1%.

The next MPC meeting will take place on March 17th. At this meeting, the inflation data for February will be available and provided the rise in inflation continues to be at a lower rate, any thoughts of a third consecutive hike in interest rates will be dispelled.

While it would be almost inconceivable for rates to be increased at three meetings in a row, the unprecedented level of support that the economy received throughout the Pandemic could provide justification.

Were that to happen, the inevitable question would be, why were the two earlier hikes not of a greater magnitude?

Last week, the pound trod water versus the dollar given that there were no significant data releases and the Prime Minister managed to avoid any further banana skins.

It reached a high of 1.3643 and closed just twelve pips higher at 1.3550.

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50bp now the general expectation

The next Meeting of the rate setting FOMC will take place on March 15/16.

At this meeting, Jerome Powell has intimated that the end of added support having taken place, the first hike in interest rates since late 2015 will take place.

There has been considerable speculation about the size of the hike. Following last week’s inflation data, which saw the headline rate rise to 7.5%, that speculation has turned into a reasonable certainty that the hike will be of fifty basis points.

To the current generation of traders, which will be a significant moment; first because it will be the first hike in more than six years, and second because a change of fifty basis points has been almost unheard of.

Having remained silent over the past few weeks, two Regional Fed Presidents, Raphael Bostic and Loretta Mester, spoke last week of their belief that inflation will start to begin to correct naturally through this year given the expected easing of supply chain problems.

However, they both also see a major statement coming from the FOMC meeting. This would most likely mean fifty basis points, since the time for verbal statements has now passed.

The clear rush to bring inflation under control after several months of seeming tauper, punctuated by some hawkish comments, could have significant consequences for the economy later in the year.

Having made a conscious decision to play catch up, the FOMC will have to be careful not to chop the recovery off at the knees.

With inflation rising at a decade’s high rate and major parts of the economy beginning to outperform, the Fed sees dealing with growth and inflation as mutually exclusive.

It is easy to look at the Fed’s actions with a degree of hindsight, but Powell was a little too sanguine about rising inflation when the issue began. As Fed Chairman, Powell should have been aware of the effect his words would have on asset markets.

The coming hikes may have an even more dramatic effect on markets than inflation racing a 30+ year high has had.

Last week, the dollar index began to correct its fall from the previous week. It reached a high of 96.11, closing at 96.06.

Pressure on Brussels to grow

When the European Union commissioned, one of the first areas that was to see cooperation was defence policy.

The current membership of the EU is now at 27 countries, and eleven of those are former members of the Soviet Bloc. This makes it difficult to understand that there has been no EU wide action as Russia continues to threaten to invade Ukraine.

The German and French Heads of State have both made individual contact with the Russian President to try to find a solution. This appears to be indicative of the current fracture within the EU, which first came to light at the start of the Pandemic.

It is obvious that any military intervention in Ukraine as a response to Russian action would be catastrophic, but the effect on the EU economy were Vladimir Putin to push the EU to the brink of war and then pull back could also have dire consequences.

There has been talk of the weaponization of gas supplies from Russia to the EU. This would see the price rise even more rapidly than it has over the past year, but it is doubtful that Russia could keep the tap turned off for too long, since the effect on its own economy would be significant.

The weekend newspapers appeared to see this week as the most likely for any action to begin.

This week, data for EU-wide GDP will be released. Full year growth is expected to be unchanged from the end of the third quarter at 4.6% while quarter on quarter GDP may have seen a slight contraction.

The fall in industrial production will remain, but its pace will have fallen from -1.5% to -0.8%. The effect of the Omicron Variant is beginning to fall, with restrictions in several countries now limited to those who have chosen not to be vaccinated.

ECB President Christine Lagarde warned on Friday that the damage to the economy from a hasty rise in interest rates to combat inflation could have even more grave consequences than the Pandemic overall. She confirmed that any change in monetary policy would take place over an extended period.

The euro was mired in a narrow range last week as volatility gave way to contemplation.

It fell to a low of 1.1329 and closed at 1.1341.