18 July 2024: Headline inflation remained at 2% in June

Despite the misgivings of its Chief Economist, the Bank of England received encouraging news regarding the future path of inflation yesterday, as the headline rate remained at 2% for the second consecutive month in June. However, the core rate is still at an elevated 3.5%, also unchanged from last month.

Today, the June employment report will be published. The change in the claimant count is likely to have fallen to around 25K, down from 50 K last month, which is a positive for the economy, but also inflationary. Still, it is wage increases that will interest the Monetary Policy Committee.

Increases in average earnings are still running at around 6% which is well above the inflation rate. This shows that the continuing high base rate is doing nothing to remove the wage/price spiral that has developed over a considerable time.

This is created when workers demand higher wages to cope with the higher cost of living. This then forces employers to increase prices, which adds to the core rate of inflation, which in turn encourages further elevated wage claims, and so on.

Once it has begun, a wage/price spiral is difficult to end, and is a major concern to the Bank of England which only has monetary policy to try to drive inflation down by reducing demand which, in theory, should cool inflation.

Headline inflation has fallen to reach the Bank’s 2% target over the past couple of months. That is due to the significant increase in energy and foodstuffs more than a year or so ago, which is no longer part of the data. Therefore, year-on-year headline inflation has fallen significantly, while core inflation is still relatively high due to the additional costs of wages, rent and other ancillary costs borne by manufacturers and the service industry.

The State Opening of Parliament took place yesterday, in which the Government sets out its legislative agenda for the following year.

The King’s Speech contained most of the bills that had been promised by the Prime Minister, such as measures to increase growth, tackle law and order, particularly anti-social behaviour, and increase workers’ and renter’s rights.

However, changes to the planning law may see new Labour MPs inundated by complaints from their constituents. These complainants have been labelled “NIMBYs” (not in my backyard), due to the lack of infrastructure that has not been built recently in areas where there have been significant numbers of houses built. Schools, healthcare services and transport infrastructure have fallen behind housebuilding, and this will need to be rectified if the Government’s ambitious plans to provide the level of economic activity are to be realized.

Although the Chancellor has begun to lobby for a rate cut at the next meeting of the MPC, the data published yesterday and today may deter it from a cut in rates until September at the earliest, although inflation is expected to begin to tick up as Autumn arrives.

Sterling has been supported by the market’s belief that the Bank of England will remain hawkish over monetary policy for at least two more months.

Yesterday, it rallied to its highest level in a year. It broke the psychological barrier at 1.30 versus the dollar, reaching a high of 1.3044 but ran into significant selling pressure and fell back to close at 1.3009.

Jerome Powell, a “card-carrying” member of the Republican Party, has been given a rough ride over the past four years as the “last man standing” from the Trump Administration.

His fortitude has been admired to such an extent that should Trump be re-elected in November; Powell may well be the single member of “Team Biden” who remains.

The performance of the economy over the past four years when it has had to deal with the fallout from the Pandemic and global issues like the Russian invasion of Ukraine has seen inflation rise to a high of 9% and forced the Federal Reserve to raise interest rates. However, the bulk of the criticism from Republicans in Congress has fallen on President Biden and his Treasury Secretary, Janet Yellen.

Yellen has already experienced being removed from her post since she was Chairperson of the Fed during the second half of the Obama administration.

Like the President, the Fed Chairman must be reappointed every four years, but unlike the President, the Fed Chairman can serve multiple terms.

So, it appears that Jerome Powell is safe in his role for at least another term, although the unpredictability of Donald Trump may still cause him some concern.

The economy is still coping reasonably well with the elevated level of interest rates that have remained unchanged for close to a year.

Data for industrial production and capacity utilization was published yesterday, as well as encouraging numbers for the housing market.

Industrial Production rose by 0.6% last month. This was lower than May’s number but better than the market had expected.

Housing starts saw a remarkable turnaround, rising by 3% after a revised fall of 4.6% in May.

Despite this improvement, the Fed appears to be fixated on the rate of inflation and the cooling of the employment market.

Powell’s comment that the FOMC won’t necessarily have to wait until inflation falls to its target of 2% to begin to cut rates, has solidified the market’s view that a rate cut may happen before the end of the current quarter.

This has seen the dollar under significant pressure over the past week. Yesterday, it fell to a low of 103.65 and closed at 103.73.

Its next major support level is at 102.80, which is unlikely to be tested unless Powell or his colleagues make far more dovish comments between now and the next FOMC meeting. However, a lot will depend on the outcome of today’s ECB meeting.

The past few months have been tough for Christine Lagarde.

First, she received severe criticism from her staff at the ECB who, when surveyed, commented that she was more suited to the role of diplomat than Central Banker.

Then, she faced almost daily questioning about when the Central Bank would cut interest rates, having survived criticism over the role of the ECB in the economy coming close to falling into recession.

This week, she has seen her influence diminished by news that economists feel that they can get a more “balanced” view of the Eurozone economy from either Isabel Schnabel or Philip Lane.

Yesterday, Lagarde tried to reassert her influence, pledging that the rate-setting Governing Council, which meets today, will “take it slow” when loosening monetary policy.

At today’s meeting, the ECB is expected to “stand pat” leaving interest rates unchanged. They have not had sufficient time since the cut was agreed at its last meeting to evaluate its medium-term effect, although comments made for the more hawkish members of the Council have anticipated a rise in inflation.

The entire Eurozone economy has been suffering ever since the cycle of rate increases was halted, with several economists and prominent bankers calling for cuts to begin far sooner than they did.

Now the ECB is being given very little time to evaluate the effect of the single cut that has been agreed so far, as the market feels that one cut should have been the start of a series that would provide a boost to the economy.

The question has been asked; “what was the point in a single isolated cut?” since it is no more than a drop in the ocean and has done nothing to alleviate the stresses in the economy yet has risked an upturn in inflation.

Given the hawkish nature of the Governing Council, the window of opportunity may be closing, since it is generally believed that inflation may begin to climb as Autumn turns to Winter.

The short-term fate of the Euro rests squarely on the shoulders of the Governing Council at the outcome of today’s meeting and Lagarde’s comments following.

Yesterday, the single currency rallied to a high of 1.0948 and closed at 1.0939.

There is expected to be significant selling interest between 1.0920 and the psychologically significant level of 1.10, so unless Lagarde is extremely hawkish in the press conference, the Euro may be close to the top of its current rally.

Have a great day!