1 August 2022: Can Bailey really justify fifty points?

GBP – Bank of England may settle debate about recession

Falling headline inflation sees the forecourt price of fuel fall by 10% in some parts of the country. The Bank of England may reconsider its plans to hike rates by fifty basis points at its meeting this week.

The fall in petrol prices has gone unheralded, as the gaze of market commentators was fixed upon the prospect of a recession. Surveys show there is little likelihood of any growth in the economy in the next three months.

If the Bank of England presses on with its plan to hike by fifty basis points, then a recession becomes even more probable.

The MPC has become more hawkish in general in recent weeks, with Catherine Mann taking up the campaign for tighter monetary policy as her colleague Michael Saunders leaves the Committee. He has fought a lone battle for interest rates to rise faster and more aggressively ever since inflation began to rise.

In hindsight, Saunders’ campaign may have been justified. If the Bank had been more aggressive when it started to hike rates last December, it might have begun to moderate or even pause hikes by now, providing a degree of support to the economy.

The housing market will begin to suffer this month as banks and other lenders begin to raise interest rates on mortgages. There is still a scramble going on for existing borrowers to lock in at higher rates, even if the current round of hikes cannot last much longer.

The race to become leader of the Conservative Party begins in earnest this week, with ballot papers being sent out to the 165k or so members of the Party.

With campaigning having become slightly less aggressive over the past couple of weeks, and Liz Truss receiving support from former and current Cabinet colleagues, Rishi Sunak has fallen behind.

He is being likened to his former boss as he continues to perform a series of U-turns, particularly about taxation. He has now suggested that he may be able to cut personal income tax by 4% if he is elected, but is still avoiding saying when that may happen.

Last week, sterling managed to rise from its recent lows, but the rally was more to do with dollar weakness than any positivity surrounding sterling. It reached a high of 1.2245 but settled back to close at 1.2179.

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USD – Inflation at 9.1% – how can the economy be slowing?

It has been the case for almost as long as economic statistics have been produced that the rule of thumb to decide if an economy is in recession is that it must see two consecutive quarters of contraction in GDP.

It is a sign of the times the Fed and U.S. Administration would want to move the goalposts, following last week’s confirmation that the economy shrunk in the second quarter just as it had in the first.

The fact that the fall was 1.6% in Q1 and 0.9% in Q2 makes no difference. Neither does the fact that employment is still rising – jobless claims remain constant around 250k per week – nor that the Federal Reserve is continuing to hike rates.

It may be that Jerome Powell, with a new title of Denier in Chief, will be announcing a new definition in the coming days or weeks.

It must be agreed that the country is not exhibiting any genuine signs of being in recession. No stock market crash, no factories closing, and certainly no high-level bankruptcies.

There were some tough words for President Biden emanating from this weekend’s political TV shows. One commented that it was incredible to see how fast Biden has driven the economy into the ground.

On the surface that may be true, but it totally ignores the extraordinary circumstances he inherited. The country was taken into lockdown not long after he took office, and it was considered the right move to provide support for those who were unable to work during the Pandemic.

It is a general rule that the Democrats promote social care and welfare programmes, while the Republicans are more likely to drive business and the economy forward, expecting a rise in activity to provide increased incomes. It is not the American way to offer handouts, to accept them is an anathema.

The main criticism of Biden, Yellen and Powell is that they were slow to see the power with which the economy was about to rebound and provided too much support for too long.

The slowdown may not have been created within the country’s borders, since trying to control demand when the issue is centred on supply, however if the Fed had begun to hike three months sooner, it would be in a far better position to provide support now.

The Fed’s veiled signal that it may be slowing the rate at which it hikes saw the dollar’s recent correction intensify last week.

The dollar index fell to a low of 105.53, closing at 105.82. The pace at which the rally happened as traders concentrated on interest rate differentials at the start of Q2 means that even a deeper correction would see the Greenback attract support.

EUR – The economy will suffer if Russia wants it to!

One of the most significant tenets by which the original European Union was conceived was to avoid conflict in Europe and to provide something of a buffer between east and west.

While there has been significant attention paid to the economy and how one size fits all can work, Russia has been (not very stealthily) planning to take back some of the land it lost at the fall of the Soviet Union.

Vladimir Putin has played ball with the EU in its supply of energy to the west, and he was able to fool even the wily, yet cynical, Angela Merkel.

Putin and his Cabinet appear to have decided long ago which of its former satellites, like the Baltic States, were of little consequence, while concentrating on strategically important countries like Ukraine.

Now, he has Europe just where he wants it and can begin to extract concessions.

The sanctions that the European Union placed on Moscow at the start of the conflict have hurt Brussels even more than they appear to be hurting Moscow. However, that may be simply because the EU views the suffering of its people differently.

The embargo on oil imports from Russia is already being reconsidered as the prospect of gas shortages across Germany and most other EU nations begins to hit home.

While not a full member of OPEC, the cartel realises that Russia can be either a counterbalance in terms of supply or a major influence. So far it has worked with OPEC to ensure that prices remain high, driven by the regulation of supply.

With the U.S. close to self-sufficient in terms of energy, the EU has taken the brunt of Russian action.

It is hard to imagine that the invasion of Ukraine is not part of a far greater plan, although a significant escalation of the conflict is unlikely to form part of it.

The Eurozone economy is likely to see the deepest recession seen by any G7 member. There remains confidence that the economy will bounce back next year but it is uncertain just how confidence financial markets feel.

The Euro has benefitted from the weakening dollar but appears to be treading water as any potential rally attracts sellers.

Last week.it was unchanged despite having fallen to a low of 1.0096. Following the FOMC meeting, it managed to rally back above 1.02, closing at 1.0274.