19 December 2022: Where will growth come from in 2023

The UK is facing an unprecedented period of industrial unrest as striking railway workers, nurses and ambulance crews as well as airport staff and teachers create havoc that is going to last well into the New Year and beyond.

Striking workers do not accept the Government’s stance over pay and conditions. The Chancellor of the Exchequer, Jeremy Hunt, has told the leaders of worker’s unions that their demands for inflation busting wage settlements are simply unrealistic and unaffordable.

On the whole, the public are adopting a Stoic attitude towards the industrial action, showing great sympathy towards health workers since their performance during the Pandemic is still fresh in their minds, although the degree of militancy being shown by rail workers, who are among the best paid of public service employees is starting to wear thin.

The Bank of England Monetary Policy Committee raised short Term interest rates for the ninth meeting in a row last week. The base rate is now at 3.50%, a year ago it was standing at just 0.10%.

While the recession that has most likely already arrived has been exacerbated by the rate hikes, they have been deemed necessary to combat rising inflation, although their effect has been minimal.

Traditionally, short term interest rates have tended to be higher than in other G7 economies, so they have taken longer to reach a neutral level where they are neither stimulating nor restricting the economy.

The latest hike will not be the last, and only time will tell if they are restricting demand to such an extent that inflation will begin to fall.

Although Bank of England Governor, Andrew Bailey, has spoken of his determination to drive inflation down, the actions of the MPC have belied his words. Four hikes of twenty-five basis points had minimal effect on prices, which were seen to be being driven by influences that were out of the Bank’s control, such as the rise in the wholesale price of fuel, while shortages of foodstuffs were driven by the war in Ukraine.

Nonetheless, the Bank’s timid performance has led to five consecutive fifty-point hikes which the Bank would have been better placed to deliver far earlier in the current cycle.

They are now stuck in a place where rates will quickly become restrictive, while inflation is not yet deemed to have topped out.

Last week, the pound rallied to its highest level since June, but the basis for its strength is fragile at best. The weakness of the dollar is due to the market’s belief that the U.S. Federal Reserve if close to calling a halt to its own rate hikes since inflation has begun to fall.

It reached a high versus the dollar of 1.2446, although it quickly lost ground, closing at 1.2161 as the full extent of what is to come painted a bleak reality.

Of the G7 nations, the UK has potentially the weakest outlook as a period of stagflation looms and the Bank of England remains locked in a battle with rising prices that have begun to abate elsewhere.

It seems likely that the market read what it wanted to see from the statement delivered by Jerome Powell at the conclusion of last week’s FOMC meeting, as the Central Bank stepped back from its recent delivery of jumbo rate hikes of seventy-five basis points and settled for a fifty-point hike.

Powell wanted to market not to be blindsided into thinking that the Fed had turned less hawkish in its battle with inflation and had become concerned over a slowdown in economic activity, his message was more driven by the recent moderation in headline prices rises which his FOMC colleagues believe to be a tentative first step.

It is very hard to restart a more severe tightening of rates once smaller increments have begun, since they will attract accusations of dithering from commentators.

The FOMC must now be 100% certain that they have prices under a degree of control. This should mean that inflation won’t rise again, although the pace of its fall is still subject to uncertainty.

It is often said that the next unemployment report is the most vital, but it is likely truer of the report that will be published on 2nd January than most. The Fed may have advance notice that employment is beginning to fall, although the expectation of several economists remains that the headline new jobs figure will have turned negative by the end of the first quarter, which at the moment appears overly-pessimistic.

Activity is expected to slow this week as the market gears up for the Holiday season. That will see liquidity fall and could magnify volatility.

On Thursday, the next release of Q3 GDP will be released. This is expected to be confirmed at 2.9%, While weekly jobless claims are likely to fall back closer to 200k

The dollar index is still driven by the prospects for monetary policy. It fell to a low of 103.43, but recovered as traders took a closer look at the outcome of the FOMC meeting and decided that the Central Bank still has a tightening bias, to close at 104.76.

There were unprecedented outbursts of fury directed towards the ECB following its decision to hike rates by fifty basis points ate its latest meeting which concluded last Thursday, as indebted nations, Italy in particular, accused the Central Bank of dancing to Germany’s tune.

Italian ministers labelled the decision to hike rates by fifty basis points as crazy and baffling. They believe that increasing the pressure on heavily indebted nations at this time to be unnecessary. They clearly haven’t read or are inclined to ignore the latest inflation reports.

Robbery Holtzman, the Austrian Central Bank Chief, comments that the only question at the meeting was whether the hike should be fifty or seventy-five basis points.

As a hawkish message from the ECB drove bond prices to new lows on Friday, ministers from several nations lined up to reinforce expectations that further fate increases should be expected.

The Italian Prime Minister, Giorgia Meloni and her deputy, Matteo Salvini were outraged at the decision, labelling it unbelievable.

It is difficult to understand that although the political landscape in Italy shifts at a phenomenal rate, politicians are not even a little used to the more hawkish nature of the Northern States.

Italian politicians of all parties are living in a fantasy world if they believe that their brand of populist, socially dominated politics will win them any favour in Brussels, Frankfurt or, increasingly, Vienna.

Italian ire was also stoked by the decision of the Central Bank to scale back the level of its purchases of Government debt as part of its balance sheet reduction.

Italy believes that the role of the Central Bank should be to facilitate its borrowings, but Brussels is in no mood to write a blank cheque. With its finances in complete disarray, the Italian Administration knows it must comply with the demands of the Growth and Stability Pact, but it doesn’t have to remain silent.

Last week, the Euro rallied to its highest level since May, and some observers see it hitting 1.10 versus the dollar as the monetary policy of the ECB and Fed diverges in favour of the Euro. It seems that at some point the bears will turn and bite the single currency and send it back towards parity.

Last week it reached a high of 1.0736, but is fell back to close at 1.0592.

Have a great day!