15 June 2023: Bailey is in the firing line, but his options are limited

The UK economy returned to moderate growth in April as services activity bounced back. Consumer activity was the strongest that has been seen so far this year.

A positive first quarter was marred by a contraction of 0.3% in March, but the economy made up for that with growth of 0.2% in the first month of the second quarter.

As fears of a recession this year recede, the Bank of England received support from the Chancellor of the Exchequer, Jeremy Hunt, who commented that the Monetary Policy Committee faces little choice but to continue to raise interest rates in the face of stubborn inflation.

He went on to say that the Government would be “unstinting” in its support for the Central Bank to do what it takes to defeat inflation.

With the base rate of interest already at 4.5% and another meeting scheduled for next week, there is speculation that it could reach 5.5% before the end of the year.

That is unwelcome news for homeowners who are less likely to support the Conservatives in an election according to a recent poll. Hunt stressed in a speech yesterday that inflation is an issue for all developed economies as the world continues to adjust to the aftermath of the Pandemic.

When asked if the issue had been worsened by Brexit, Hunt was a little coyer, commenting that the war in Ukraine had had a far more dramatic effect, and would continue to do so.

By the end of 2023, it is estimated that 1.6 million households will see the end to cheaper fixed rate deals and will be forced to bear an added cost of approximately two and a half thousand pounds.

Almost all the major banks and building societies have pulled fixed rate products from their offering as they seek to introduce higher interest rates and increased fees.

Hunt was asked if he agreed with then Prime Minister John Major’s comments in 1989, that “if it’s not hurting, it’s not working”, to which he replied that all Governments are forced to make difficult decisions while they are faced with the difficult task of increasing consumer spending and seeing businesses invest in their futures.

The Jury is still out on the prospect of the UK facing a recession before the forthcoming General Election which must take place before January 2025. Currently, the economy is “bumping along the bottom” while Rishi Sunak and his Cabinet seek to restore confidence which has taken another blow recently following the resignation from Parliament of former PM, Boris Johnson.

The pound saw a strong rally, in the aftermath of the announcement from the FOMC that they were pausing their cycle of interest rate hikes.

It rose to a high of 1.2699 versus the dollar and closed at 1.2666. This was its highest close so far in 2023.

The interest rates futures market is predicting two further rate hikes this year as the latest meeting of the FOMC ended with Jerome Powell, the Chairman of the Central Bank announcing that the committee had voted to leave rates unchanged this month.

In announcing the pause, Powell went on to stress that neither he nor his colleagues believe that the time has come to “bring the curtain down” on Fed’s bias towards tighter monetary policy.

Headline inflation has slowed to a two-year low in May, despite a strong employment market causing core inflation to remain persistently high.

Powell bounced back and forth during his news conference, first extolling the virtues of the fall in inflation and then warning that borrowing costs are likely to rise to a level that was not predicted earlier in the year.

Despite the pause in interest rate hikes, there is still lingering concern about a recession last in the year, and Powell made no attempt to alleviate those fears.

He was faced with having to explain two contradictory policies, one of which that the Bank will need to apply in the coming months. He commented that the pause would enable the economy to “catch up” with the hikes that have taken place already and allow the FOMC to have further data with which to make “better decisions”.

Members of the FOMC believe that the economy is sufficiently resilient to withstand higher interest rates, although a lot depends on the jobs market, which hasn’t responded to the cycle hikes as had been expected.

The turmoil created by the collapse of three banks earlier this year has not evaporated completely, and there are still concerns over market liquidity and increased risk premiums.

Having included four jumbo-sized hikes each of seventy-five basis points over the past eighteen months, the Fed believes that the “heavy lifting” has been completed but still is cautious about any flare-ups that must be dealt with promptly.

Overall, the FOMC believes that it has brought monetary policy back to where it needs to be given the past ten years of accommodation.

Whether it needs to restrict demand, any further will be a question it will need to answer going forward.

The dollar index predictably suffered in the wake of the Fed announcement. It fell to a low of 102.66 but recovered to close at 103.01.

The Governing Council of the ECB concludes its latest meeting today, and there is no doubt that they will announce a further tightening of monetary policy. A twenty-five-basis point hike is “baked in”.

All that is left for the market to speculate about is whether ECB President Christine Lagarde will hint that the policy of rate hikes is ending.

It is clear that the committee had given Lagarde free rein to continue her hawking comments since the criticism of her usurping the authority of the Governing Council has totally evaporated.

With market practitioners and investors believing that the July meeting will see the end of the cycle of rate hikes, it is hard to imagine Lagarde performing such a “volte-face” without even the slightest advance guidance to the market.

Data for industrial production in April was published yesterday, showing a marked improvement in the March figures.

The one lingering concern for the economy going forward was the disappointing level of advance orders which predicts that the economy may remain in recession for not just this quarter, but should the cycle of hikes persist after July, the next one as well.

The conditions that led to the collapse of Silicon Valley Bank, namely the level of unrealized losses due to the sharp rises seen in interest rates do exist in the Eurozone but are far less significant than in the U.S. even now.

The Regulator for Eurozone Banks believes that accounting for past bad loans is still a more severe issue and the most significant drain on profitability is funding those debts which provide no return.

After today’s interest rate decision, the focus will no doubt be on what the ECB plans to do next. There will no doubt be further comments made from the more dovish member states about how close the ECB is to fulfilling its goal to make interest rates more restrictive on demand, while the hawks of the Frugal Five will likely keep their own council, safe in the knowledge that the ECB will “do the right thing.

The euro received a boost yesterday from the notion that it will become more expensive and therefore less attractive to short the Euro going forward.

The single currency rallied to a high of 1.0864 but, more significantly, closed at 1.0828 challenging the resistance that has been in place since the last time it reached the 1.10 level.

Have a great day!