17 May 2023: Average earnings are still too high for a Bank of England pause

The April employment report was published yesterday, and it showed that average earnings are still well above where the Bank of England needs to be to see inflation fall back close to its target of 2%.

The headline figure, excluding bonuses, grew year-on-year to 6.7%, up from 6.6% a month earlier.

The data shows that the economy is at something of an inflection point, with momentum beginning to turn, but that will likely come too late for the next Monetary Policy Committee Meeting.

The data has remained in the same “ballpark” for a few months now and this will concern the Central Bank since it is a sure sign that inflation is becoming imbedded in the economy.

The peak in wages may be close should the unemployment rate, which unexpectedly rose to 3.9% from 3.8% last month, continue to creep higher. Workers tend to become more satisfied with their lot as they become aware that new jobs are becoming scarcer.

The data doesn’t make the Bank of England’s decision any easier, the next rate hike, if it happens at all, is balanced on a knife edge. At the last meeting the decision to hike was made by a majority of 7-2, with the same two dissenting voices that have voted against for the past couple of meetings.

Those voices belong to two of the independent members, Swati Dhingra and Silvana Tenreyro. Both have expressed concerns recently that the Bank is moving too quickly and not allowing rate hikes that have already taken effect to have their full effect.

Huw Pill, the Bank’s Chief Economist spoke yesterday of his regret over his choice of words in a speech recently in which he said that British people should get used to being poor. Speaking last month, Pill used what he now considers inflammatory language to get his point across.

He said that rather than bidding up prices by trying to maintain purchasing power, the population should accept that they are poorer and stop demanding higher wages which fuels inflation.

He spoke on Monday evening of his regret at his choice of words and should have described the challenges we all face (some more than others!) in a different manner.

The market remains as undecided about the path of Sterling as it is over the next MPC decision. Yesterday the pound retreated from the highs seen on Monday, falling to a low of 1.2465 and closing at 1.2489.

A number of FOMC members have taken advantage of the gap between meetings to discuss their view of the U.S. economy and whether the time has come for a pause in the run of interest rate hikes that have continued since the Spring of last year.

Raphael Bostic, the President of the Atlanta Fed commented that he is inclined to seek a pause, so as to be clear what effect of the tightening of credit conditions is having, with the full weight of changes to monetary policy over the past year not yet being fully felt.

He went on to say that business owners in his region are concerned that the Central Bank is in danger of overdoing it and overshooting its targets regarding inflation and employment.

He acknowledged that the Fed has something of a history of overshooting whether tightening or loosening monetary policy and that is something the Central Bank needs to guard against as policy reaches a critical stage.

Bostic’s colleague, Tom Barkin of the Richmond Fed., remains unconvinced of the need for a pause. He spoke recently of his concern that demand needs to be further impacted in order for inflation to come down permanently.

He feels inflation has been fitful recently while the labour market has only gone from red hot to hot and needs to be dampened further.

The psychological effect of the Fed Funds rate reaching 5% is yet to be felt by the market although Barkin agreed that the Fed is Very close to being able to pause its policy of tighter monetary policy.

There is a view in the market that due to some combination of recession and lower than forecast inflation the Fed will cut rates this year. Neither would FOMC members comment on that other than to say that a cut has not come up in discussions.

The dollar index remains in a state of flux without any discernible trend. Yesterday, it rose to a high of 102.69 and closed at 102.60. With inflation and employment reports being the two most significant drivers of the currency, any trend that is seen outside of those two events remains short-lived.

The popular view of the next two of three meetings of the ECB’s Governing Council is that there will be two further hikes in interest rates, followed by a pause as the Central Bank reviews the effect that tiger monetary policy is having on the economy and perhaps more importantly inflation.

The ECB doesn’t want the market to speculate as to when the current cycle of interest rate hikes will come to an end, and it certainly doesn’t want to signal a pause only to have to go back on its word or restart hikes a couple of months further down the road.

There has been something of a coming together of policy makers at the past two or three meetings with the more dovish members accepting smaller incremental rises without complaint while the hawks accept that rates continue to rise in line with their concerns over inflation.

In the words of ECB President, Christine Lagarde, inflation remains sticky as the headline issues caused by runaway wholesale gas prices have been replaced by the gentler increase to the core caused by above inflation wage increases and remaining government support packages.

Underlying the battle with inflation is the continued apparent stagnation of the economy.

With industrial production struggling to make any headway as export demands falters it is creating a typical situation of struggling to move further into expansion while continuing to avoid any significant contraction.

The lack of any concerted fiscal policy agreement and concerns over a possible banking crisis are being considered as reasons why the ECB may pause its cycle of hikes in the coming months, but it is more likely to ensure that inflation is securely of a downwards path towards the target of averaging 2% before any precipitous action is taken.

The Euro is attracting support at around the 1.0840 level but remains unable to break the 1.10 barrier conclusively. Until there is some clear guidance from the Central Bank, the current situation could continue until the summer lull.

Yesterday, the single currency lost ground against the dollar. It fell to a low of 1.0855 and closed at 1.0862.

Have a great day!