1 June 2023: MPC’s Mann sees core inflation as a “continuing” issue for the UK

The MPC’s most hawkish member Catherine Mann made a speech yesterday in which she again raised concerns about the potential for inflation to become ingrained in the UK economy.

Mann believes that the UK has a more significant issue with core inflation than most of its G7 partners. She said that it was a structural issue where companies, both public and private, are so desperate to protect their profit margins that they pass wage increases directly to their customers by increasing the price of their products.

One classic example of this is the railways, which are supposedly privatized but the Government is currently engaged in a tough series of negotiations with several sectors of the industry. The UK has the highest train fares in Europe or the U.S., while its service is mediocre at best.

The cost of a ticket bears little relationship to the distance travelled, the frequency of the service, or the condition of the rolling stock or infrastructure.

Inflation in the UK reached a high of 11.2% in October last year and in April was still at 8.7% making the UK the joint highest, with Italy, in the developed world.

Headline inflation is falling, mainly due to the drop in the wholesale cost of energy which is welcome, but until wage increases slow core inflation will be uncomfortably high. This has the knock-on effect of sling economic growth as the consumer still has commitments over their household budget that leaves whittle wiggle room.

The Bank of England has raised short-term interest rates twelve times in succession since December 2021, and although there is mounting pressure on the Bank’s Governor for a pause, Mann believes that there is little opportunity for that to happen until there is real progress made in curbing core inflation.

Mann is also concerned about potential volatility in currency and asset markets. She believes that the “water is always calmest before a waterfall”.

The Government has contributed to the issue of core inflation as it raised both the minimum wage and certain benefits to a level that is at or above the rate of inflation. It is true that there was little option for Jeremy Hunt but to exercise the “triple lock” on state pensions. However, the effect has meant that interest rates will need to continue to rise.

It is unlikely that the Central Bank will see any alternative but to raise rates for a thirteenth time later this month, but while the financial markets are on the cusp of the summer lull, it may be a bumpy Autumn.

Yesterday, the pound saw increased volatility as it first rose to a high of 1.2443 versus the dollar, then fell to a low of 1.2348 before recovering to close at 1.2440. A lack of liquidity was blamed for the lack of support which saw sterling challenge short-term levels of support.

Data released yesterday, showed that job openings rose back above ten million,while the numbers for April were upwardly revised. This points to a continued tightness in the labour market which Fed Chairman, Jerome Powell, hoped was beginning to recede.

Both Philadelphia Fed President, Patrick Harker and Fed Governor and President Biden’s pick to be the new Deputy Chairman, Philip Jefferson spoke yesterday of their belief that the FOMC can afford to pause the cycle of interest rate hikes that has gone on since last Spring.

Jefferson was almost strident in his belief that if a pause was announced in short-term rate hikes the market would need to be convinced that it was indeed a pause and not the end of the cycle.

“There would be no reason to assume that rates have peaked simply because the committee feels that a pause to allow some time for reflection and the full effect of past increases to be felt”.

Market analysts and commentators find that a very hard argument to make since core inflation remains a stubborn foe.

Harker feels the same although he labels the possible action as a “skip” and not a pause.

He feels that monetary policy is close to being restrictive on demand if it is not already. He sees tomorrow’s employment report and inflation data, due on the first day of the FOMC’s upcoming two-day meeting as crucial.

“It may be that we still have more to do, but right now we have an opportunity to skip a meeting, since the economy, while resilient, would benefit from a “breather”.

Job openings reached their highest level since January and this is a strong indicator that the headline number will again be strong when the May employment report is published tomorrow.

The dollar index spiked to reach a high of 104.70 following the data but retreated as the comments from Harker and Jefferson cooled expectations for a further tightening. It fell back to close at 104.22.

Having failed, or possibly simply been outvoted at the past few meetings of the Governing Council of the ECB, to convince their colleagues of the need for a pause in rate hikes, the more dovish members, headed by Banca do Espana Governor, Luis de Guindos appear to have adopted a fresh tactic to achieve their goal.

De Guindos spoke yesterday of his concern about the fragility of the Eurozone’s financial markets and the remaining threat of contagion following the effective collapse of Credit Suisse.

“Any further shock to the global economy could send the markets into a tailspin that could take years to recover from and the continual hiking of short-term interest rates may be a catalyst for such an event” said De Guindos.

The opposite is true of the hawks on the Governing Council who see continued high inflation as a possible precursor of such an event.

The ECB published its May report on financial stability and it appeared to concur with the views of the Spaniard. The Central Bank believes that the collapse of three banks in the U.S. Has partially been due to the rises in interest rates in the U.S. and a similar chain of events could easily take place in the Eurozone.

However, the report did go on to say that bank resilience in an era of rising interest rates was not a concern currently, with fundamentals strong and oversight proving effective.

The strong beginning to 2023 by equity markets in general, the gradual reopening of China and the surprising resilience of the Eurozone economy given the upheavals caused by the war in Ukraine are positives, although there will need to be some adjustment or correction to the end of the era of low-interest rates and close to zero inflation.

There remains a feeling that the ECB may end its cycle of rate hikes following its July meeting, giving markets August, traditionally an exceptionally quiet month to adjust. That coincides with the view that two more hikes will provide the Hawks with sufficient confidence that inflation is firmly on a downward path.

The euro briefly dived to its lowest level since mid-March yesterday as the data was released in the U.S. It recovered following the slightly dovish comments from FOMC members to close at 1.0689.

Have a great day!