16 April 2024: Bailey is still confident about inflation

The Governor of the Bank of England appeared before the House of Commons Treasury Select Committee yesterday and continued his recent upbeat view of the economy.

He told MPs that the economy is already showing signs of an upturn, after dipping into the very shallow recession that he had predicted during his last testimony.

He also told the cross-party committee that, in his opinion, inflation will fall to 2% in the coming months before picking up again later in the year.

The recession that was over almost as quickly as it had begun bears no comparison with previous recessions over the past fifty or sixty years since the fall in GDP barely registered on the precise scale used to measure a recession with two successive quarters of contraction the “basic minimum.”

During the recessions of the seventies, the cumulative fall in output was much larger at around 2.5%, so by comparison using the size and the duration of the latest downturn it barely registered.

Fellow MPC member Ben Broadbent, who accompanied Bailey, commented that other nations, including the U.S., use the same scale to measure a recession, and the contributory factors vary widely.

In an eagerly awaited book about her brief time as Prime Minister, Liz Truss wrote that she had wanted to dismiss Bailey from his position since he not only didn’t support her catastrophic mini-budget which caused mayhem on financial markets, but actively “canvassed” for its reversal.

Even now, she believes Bailey should resign over the issue and be critical of how Labour Chancellor Gordon Brown originally set up the Monetary Policy Committee.

There is definite support in the House of Commons for her view that there should be a representative from the Treasury as a permanent member of the Committee. She feels there have been mistakes in deciding monetary policy since rates had been “too low for too long”, while quantitative easing had done a lot of damage.

She disagrees that the Chancellor of the Exchequer should be solely for creating monetary policy. Still, the MPC, overseen by the Office of Budget Responsibility, another unelected body, needs more accountability.

The timing of rate cuts by G7 Central Banks will be the most significant driver of the currency market until their intentions become clearer.

Yesterday, the Sterling continued to be buffeted by the view that the MPC will agree to a rate cut some months before the FOMC in the U.S.

Initially, the pound rallied close to 1.25 versus the dollar, but more hawkish comments from FOMC members saw the dollar gain further traction, driving the pound to a low of 1.2435, eventually closing at 1.2445.

Employment data for March will be published later this morning, with the claimant count having less impact than the level of wage increases. It is expected that average earnings will have fallen marginally to 5.5% from 5.6% in February, but this is still too slow for rates to be cut before June.

The President of the New York Fed, John Williams, brought an air of realism to the financial market yesterday, cutting through the concerns that the FOMC may not be able to cut interest rates at all.

Williams, possibly the most influential of the Regional Fed Presidents, given that he presides over the largest money centre in the country, if not the world, told reporters that he expects rate cuts to begin later this year. He feels that the market got a little ahead of itself in believing that as soon as the FOMC voted for rate hikes to end, that cuts would begin imminently.

That unrealistic view had led to widespread disappointment, due in no small part to committee members’ comments being misinterpreted. When reporters were told that rate cuts would start soon, they looked at that in terms of months, not quarters.

Jerome Powell has always tried to be rational about when cuts would start but was unable to be more specific, given that the Fed still is driven by the data.

Recent news on inflation has indeed been disappointing, but no one believed that the fall in price rises would be linear.

Traders and investors believe that there has been a sea change in the attitudes of several FOMC members to rate cuts, but Neel Kashkari and Raphael Bostic have simply clarified long-held views.

Yesterday, Boston Fed President, Susan Collins added her voice to “Team Cautious” commenting that rates will come down, and the current environment calls for patience.

Data for manufacturing output and capacity utilization is due for release later today, Output has remained above the level that separates expansion from contraction while capacity utilization remains healthy but also shows there is still room for further growth.

The Director of the Centre for Research and Analysis said yesterday that both the economy and “big banks” are in a healthy state and rates can stay at their present, elevated, state for several months to come.

The dollar index is still well-supported, as much by comments from Fed officials as those from other G7 central banks.

The Greenback continued its rally yesterday, climbing to 106.24 and closing at 106.20.

There has been a popular misconception about the Eurozone economy and its constituent parts that goes back to the commencement of the monetary union.

It is that each member of the Union not only started at an equal point but efforts to create greater fiscal discipline in individual economies that had been used to both high inflation and boom-bust were doomed to fail.

Most nations indeed paid lip service to the growth and stability pact, but in truth, they never believed in it as a policy alternative. This is perfectly illustrated by the frequent number of times that the European Commission had to fine nations who overstepped in allowing either their budget deficit or debt-to-GDP ratio, or both, to exceed the upper limit.

It is now obvious that nations like Italy knew full well that as soon as there was a crisis, that pact would be abandoned.

It took the Pandemic to make Brussels do away with the rules, and now they face an even more arduous task than when they were originally implemented.

Now priorities have changed and in the “new” Eurozone, the “tail is wagging the dog”.

Germany can no longer dictate how the rest of the Eurozone manages their economies. To now be called the “sick man of Europe” wrinkles with Germans who have got used to being able to “force” other members to be more fiscally responsible.

It is now obvious that if they were left to their own devices over fiscal policy, they would use it to dilute the most extreme effects of tighter monetary policy.

Now as the green shoots of recovery are beginning to be seen, it is time for Brussels to look out across the devastation that the past five years have wrought upon the Eurozone economy and try to exert some discipline that will be tough enough but also inject a level of realism.

Data for industrial production was published yesterday. It showed a remarkable turnaround. From a fall of a downwardly reviewed 3% in January, production grew by 0.3% in February.

Naysayers will say that production had got so weak that it had to bottom out at some point, but it is also true that even the longest journey begins with the first forward step.

Inflation won’t be helped by the continuing fall in the value of the Euro. Its recent fall has as much to do with Christine Lagarde’s recent comments about the ECB going it alone, as it is the perception that the FOMC has suddenly turned more hawkish.

Yesterday, the common currency fell to a low of 1.0620 and closed at 1.0624. It has now breached the level at which it began its period of strength that began in November of last year.

Have a great day!