BoE to await outcome of delayed lockdown

UK inflation rose to 2.1% in May, breaking through the Bank of England’s 2% target.

While this was expected, it serves to remind those who believe that the Government should extend several of its support packages that the time is approaching when the economy will need to support itself.

The year-on-year data also exposes just how weak inflation was in May of last year. The country was reeling from the first lockdown as the brakes were slammed on.

This is the first time the Government’s inflation target has been exceeded in over two years.

Economists polled by Reuters expected a rise to 1.8%, but breaking 2% shows that the rate at which prices are rising is well above market expectations.

This points towards a more hawkish outcome from the next MPC meeting, although it is likely that, in line with the Fed and ECB, BoE Governor will try to squeeze as much benefit as he can from the Bank’s QE programme before the fun has to stop and reality returns.

Despite pressure to the contrary, the furlough scheme is going to be withdrawn at the end of September and the effect of that on all areas of the economy will be an unknown that may reverse gains made in several sectors.

Fuel prices were one of the main contributors to the rise in inflation, rising by 18% in a year. It is no surprise that as the global economy begins to come out of hibernation that the oil price would serve as a major indicator.

The Bank of England has already revealed that it expects inflation to reach a high of 2.5% this year, but given the pace at which the economy is recovering that may need to be revised. It expected fuel price rises to begin to fade and bottlenecks in supply chains to even out towards the end of the year.

The MPC meets in a week’s time and there is little expectation of any change to monetary policy, although the market will call for greater advance guidance of its intentions.

The pound was driven by several factors yesterday. It fell to a low of 1.3982 as the FOMC outcome strengthened the dollar. It closed at 1.3982, its lowest closing level since May 7th.

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Inflation forecast continues to rise

The dollar reacted positively to comments made by Fed Chairman Jerome Powell in his post-FOMC news conference. Powell said that the conversation about tapering the Bank’s support for the economy had begun, but this doesn’t mean imminent change.

In its latest economic forecast, the Fed expects two rate rises by the end of 2023 as the anticipated pace of tightening increases.

Powell said the conversation centred on how fast the economy had recovered, which had clearly exceeded expectations. He saw no reason for the recovery to slow, although the time for tapering is still some way off.

He will hope that the markets will be satisfied with the level of guidance that has been provided, but now that the question of if has been answered, traders will turn to the question of when.

Powell showed his cautious side, labelling this as the meeting when talking about talking about tapering began.

The FOMC clearly wants to ensure that every stage of its plan for the recovery has been met before moving to the next phase.

The dollar index had been waiting for this kind of encouragement for some time, and traders took full advantage.

The index rose to its highest level since the recovery began to take hold. It rose to a high of 91.40 and looks set to test medium-term resistance at around 91.75/80

With employment data continued to improve at a more sustainable rate and jobless claims falling for several weeks, there is little to stop the recovery now and with inflation rising at a far higher rate than had been expected, the pressure will remain on the FOMC for some time to come.

Until the future is clear, the ECB will prevaricate

When managed by bureaucrats, the ECB was content to remain in the background managing the economy without fanfare.

It has been a little disconcerting that under Christine Lagarde, even though the Bank has had little to say on the economy, it has done so with a degree of flamboyance not seen before.

The start of the recovery from the Coronavirus Pandemic has provided Lagarde with a platform to perform. She is beginning to play to the crowd a little, attempting to feed the market titbits of encouragement that tapering of support will begin but delaying the actual reveal.

She clearly struggles to deal with a gang of twenty five, an unwieldy group each with its own agenda, although she has managed to at least divide them into two factions. The dividing line comes where the need for support begins.

Every day, it seems another Central Bank head pleads the case for either continuing support or the beginning or tapering.

The beginning of the withdrawal of support is still some way off and Lagarde may need to defy her need for the limelight for a little longer.

The fall in the euro that began yesterday may, depending on its pace, force the ECB’s hand as it will contribute to inflationary pressures.

The single currency fell to a low of 1.1984, closing at 1.1994.