16 October 2023: Bailey believes the outlook is better than a year ago

Speaking at the Annual Conference of the IMF in Morocco, the Bank of England Governor commented that he may be the only Head of a G7 Central Bank who is able to say that the prospects for the country are brighter than they were twelve months ago.

It is true that the UK has emerged from the energy crisis well, but inflation still is a significant issue. Bailey was a little unclear about the reason that the MPC paused its long cycle of interest rate hikes last month since the data that was published didn’t point to such action being necessary.

There has been some criticism from observers of monetary policy that the permanent members who hold the “whip hand” in the policy process lost their nerve in the face of concerns that since rates are already restricting demand that a further hike will see the country face a recession as winter arrives.

Catherine Mann, one of the independent members of the MPC is well known for her view that rates should continue to increase, even “overshooting” and driving a short contraction to see inflation at, or even below, the Bank of England’s 2% target.

While former Governor Mark Carney supports the Labour Party’s economic plan put together by his former employee Rachel Reeves, he also should be shouldering some of the blame for inflation becoming ingrained in the economy.

During his Governorship, interest rates remained at historic lows for perhaps longer than was necessary, and the Bank became reactive to what was happening in the economy without consideration to its cyclical nature.

Andrew Bailey had been left with little choice given the situation he inherited where fiscal policy needed to be exceptionally accommodative given the support that then Chancellor, Rishi Sunak, was pumping into the economy to aid the recovery from the Pandemic.

Last week, saw monthly GDP data published that showed a recovery from the monthly contraction that took place in August. The economy grew by 0.2% in September after a 0.6% contraction a month earlier.

Jeremy Hunt, also speaking at the IMF conference gave a clear incision that he is not going to deliver vote-winning tax cuts in his Autumn Statement. He commented that the recent deterioration in public finances meant that borrowing will be twenty to thirty billion pounds higher than forecast which is forcing him to make “difficult decisions”.

The week will see indicators released which will have significant bearing on the next MPC meeting. Tomorrow, the September employment report will be published. It is expected that average earnings will remain well above headline inflation. This is a legacy of private sector pay awards that were agreed in the summer and should begin to fall going forward.

On Wednesday, inflation data will be released. Headline inflation is predicted to have fallen from 6.7% to 6.5%, while the core may have broken 6%.

This data will make the decision at the next MPC meeting, which takes place on 2nd November, a tough call.

The MPC is hoping for evidence that rates have indeed reached a restrictive level, but they may have to wait until wage deals have been fully absorbed into the economy for that to become clear.

The pound suffered from the market’s renewed risk aversion in the face of the developing situation in Israel and Gaza which saw the dollar rally. It fell to a low of 1.2122 and closed at 1.2142.

By keeping his commitment to the phasing out of fossil fuels, the President has seemingly placed the U.S. at a strategic disadvantage to China which last week virtually abandoned its pledge to internal combustion by 2060.

China claims that it will need far longer to create the infrastructure that can support such a move. Observers believe that this move will need to be matched by President Biden if the U.S. is not to be overtaken by China as the only true global superpower.

Jerome Powell has been stoic in his view that interest rates should not only continue to be raised by the FOMC, but rates should remain high until inflation has been “banished” from the economy.

Powell will understand economic progression, while subject to a series of imponderables and shocks, is cyclical in nature and as soon as inflation reaches its lowest point, pressures in the economy will begin to build that leads to its rise.

It is the period that inflations “tame” that Powell is trying to make as long as possible, and he believes that cutting rates prematurely will be simply “feeding the beast”.

His battle to continue the cycle of rate hikes hasn’t been fought by the Chairman alone, and he has received support, mainly from other permanent members of the FOMC, but he is believed to be beginning to feel that a certain “easing off on the brakes” may now be possible to allow the economy to begin to grow at close to its potential.

He still sees the employment market as strong, an opinion that was backed up by the most recent jobs report. In that same report, wages fell only slightly. Powell will want to see a more significant and sustained fall before he “signs off” on the end of rate hikes.

There are rumours that in a speech this week he may display a slightly less hawkish view on the economy, expressing concerns that there are a series of headwinds on the horizon that will “not react well” to further rate hikes.

A surprise escalation of the strike action by the UAW which called close to 10k workers are a Ford plant in Kentucky out on strike may have been a tactic for the Union’s leadership that shows that it remains committed to new contracts for workers, but may also, counterintuitively have shown that the strike has been taken as far as it can and a settlement may now be considered.

The U.S. is working hard behind the scenes to make sure that Israel considers restraint when the ground invasion of Gaza begins and not allow “outside” influences to become involved.

As is usual in times of global tension, the dollar has gained ground on a “flight to safety”. The dollar index rose to a high of 106.78 last week and closed at 106.67.

This week, the situation in the Middle East will remain at the centre of events, while domestically, housing market data will be published and there will be speeches from several FOMC members.

The President of the ECB appears to want to “have her cake and eat it” in relation to the Central Bank’s continued programme of interest rate hikes.

With inflation staying well above the 2% target there doesn’t appear to be much home of the long-awaited pause in the cycle of hikes at the next meeting of the Governing Council, which is scheduled to take place on 26th October.

In an interview published this weekend, Christine Lagarde pronounced herself happy how employment was “holding up” in the face of interest rates that are bordering on restrictive, while also commenting that wage increases are contributing to continued high inflation.

She is likely expecting that any fall in inflation will temper wage demands but the actions of the ECB could have led to a “chicken and egg” situation.

The ECB is not prepared to halt or even pause the cycle of rate hike until wage settlements fall since it feels that a pause will not only send out the wrong signals but will also allow the doves on the Governing Council to gain the upper hand.

This seeming impasse is leading the entire Eurozone into recession but are two significant factors at play. The first is that there are “pockets of growth” that will remain as certain economies, for example Spain, which have seen inflation fall to an acceptable level, and they are able to cope with “moderate” rate hikes.

Also, the more hawkish Eurozone members like Austria and Latvia and even Germany, are prepared to suffer a mild recession to defeat inflation and set the region on a more stable footing.

The only “fly” in that particular “ointment”, is that there needs to be structural reform that goes hand in hand with tighter monetary policy to ensure that the cycle of low growth isn’t prolonged.

Inflation data is due for release this week. With the harmonized rate expected to be unchanged at 4.3%. That is unlikely to encourage a change of heart from the ECB which, according to the market, is “long overdue” a change of policy.

The Euro is not displaying any of the signs that it may be a potential replacement for the dollar as a global reserve currency. Last week it reacted poorly to the situation in the Middle East, felling to a low of 1.0495 and closed at 1.0511

Have a great day!