15 June 2022: All BoE results are possible

GBP – BoE needs to remain in lockstep with fiscal policy

It has become a cliché, but this week’s meeting of the Bank of England’s rate setting Monetary Policy Committee could be the most important since the financial crisis fourteen years ago.

While the independence of the Central Bank is now enshrined in legislation that has been in place thirty years, questions are being asked about how at this crucial time in economic policymaking why the Government is not more involved in a large part of the process.

There is obviously dialogue between Rishi Sunak and Andrew Bailey, but it is by no means certain that the Committee will vote to adjust monetary policy in a way that concurs with fiscal policy.

The issue that the authorities face is how can you ensure the independence of the Central Bank, but also ensure that it works in harmony with Government policy.

Yesterday saw the release of the May employment report. The claimant count fell again, but not by as much as had been expected. In May, the number of people claiming unemployment benefit fell by 19.8k. This was well below the expected fall of close to 50k. Wages continue to rise, but the rate of increase was lower than was seen in April. Including bonuses, wages rose by 6.8% in May, below the previous rate of 7% and below market expectation which was for a rise of 7.6%.

Even as the economy continues to stutter, the number of people in employment is at a record.

The Bank of England is under severe pressure to get its call on monetary policy at its meeting this week. It is stuck between runaway inflation and the prospect of a major recession. Common sense dictates that it should tackle the issue that is already here, so it is likely that interest rates will rise again this week.

There is a school of thought that believes a pause in rate hikes should take place in order to assess just what is happening in the economy that higher rates would solve. Several of the inflationary issues facing the economy are out of the hands of the Central bank or, indeed, the Government. But sitting on its hands is a luxury the MPC cannot afford.

Yesterday, the pound continued its recent fall and broke through the significant 1.20 versus the dollar.

It reached a low of 1.1933 and closed at 1.1996.

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USD – The hike is certain, its magnitude less so

Financial markets remain in the grip of Central Banks as they battle to contain inflation within economies that are beginning to falter after the encouragement that each received from the end of the Pandemic.

It is time to look forward in terms of monetary policy, and although the FOMC is in danger of exacerbating the lack of awareness it showed last summer.

The feeling was that it was only natural that inflation would begin to rise as demand began to outstrip supply in the wake of the Pandemic. It continued with supportive policies when, with hindsight, a policy of slowly raising interest rates would have been more appropriate.

In the defence of Jerome Powell and his colleagues, they were on new ground having seen the largest fall and greatest recovery ever seen in the economy and were to all intents and purposes unsure of the effect any change in policy would have.

Now, the economy is beginning to falter and there are confusing noises coming from almost every source regarding the possibility of a recession.

The Fed took a major policy decision a few months ago when it was recognized that inflation wasn’t going to go away of its own accord. Powell and his colleagues have become far more hawkish in their comments, but they are at least all singing from the same hymn sheet. Speculation remains that there could be a seventy-five-basis point hike when the meeting ends later today, although the market still expects fifty.

Even a fifty-point hike with another particularly hawkish press conference will leave the markets concerned about what is to come.

Until the Fed is comfortable that inflation is beginning to abate naturally, it will continue on the path to higher interest rates.

The concerns over energy prices remain, with the price of petrol continuing to rise and the news yesterday that a plant which produces around 20% of U.S. gas exports including ten percent of Europe’s imports, will be off-line for at least three months and won’t return to full capacity until the end of the year.

The market has been in risk-off mode this week, which has seen the dollar index return to recent highs. Yesterday, it rose to a high of 105.65, closing at 105.47. Threats being made by the Bank of Japan to intervene to halt the slide in its currency is a throwback to the past, but the Japanese Government will want to consider the ramifications of such a policy before it puts anything in place.

EUR – Economic data a long way from encouraging

Out of the frying pan into the fire.

The concerns being voiced about the new, more hawkish monetary policy being instigated by the ECB have raised concerns about a sleeping dragon within the Eurozone economy.

One of the issues that will be a consequence of the raising of interest rates next month, whether by twenty-five or fifty basis points, will be the consequent rise in longer term interest rates, which sees the interest burden of several heavily indebted nations rise considerably.

During the Pandemic, the financial regulator suspended the various controls it uses in order to allow exceptions to take place. However, it will be forced to wait longer to reinstate the rules since debt to GDP ratios are set to remain high while the 3% rule for budget deficits will be impossible to meet.

This all comes before the ECB begins to divest itself of the majority of its holdings of Eurozone Government debt in an effort to reduce the size of its balance sheet.

There are rumblings beginning that the Central bank should hold onto its stock of bonds and agree to replace them as they mature.

This could have the effect of making some countries’ issues virtually perpetual and would alter the dynamic of Government funding within the Union permanently.

This could lead to a long-term solution to what is essentially a short-term issue, but the alternative of seeing some economies crippled as Governments would be forced to cut back on public spending and most of the social care programmes that have been the lifeblood of the recovery.

Some commentators are beginning to reintroduce the concern over how the European Union can survive such an upheaval in its present form. The leadership is insufficiently strong to be able to bring all the members together to discuss fiscal unity, while nations who are unable to fund themselves in the traditional manner will begin to question the benefit of such a Union.

Most of the issues facing the EU are of its own making, but political will is such that the majority believe strongly that they are better presenting a united front.

The euro continues to suffer at the hands of a strengthening dollar as risk appetite wanes in the face of higher interest rates.

Yesterday, it fell to a low of 1.0399, closing at 1.0409 as the market doesn’t appear willing just yet to push it any closer to parity.