1 September 2022: Sterling breaks 1.16 versus dollar

GBP – Weakening currency to add to inflation woes

Sterling is suffering from the country’s economic prospects, as traders see the Bank of England being helpless to halt the seemingly endless rise in inflation. It feels like almost every day there is a further prediction of a quite incredible rise in inflation, with the latest being 25% early next year.

With activity, particularly in the manufacturing and industrial sectors, slowing alarmingly, the new Prime Minister will take over at what could be a historically critical time.

Liz Truss or Rishi Sunak will be expected to announce new policies to ease the cost-of-living crisis, with figures published yesterday showing that the latest increase in the cost of living will push a further three million families into poverty.

Parliament returns from its summer break next Monday, the day on which the result of the Conservative Party leadership contest will also be announced. Without having confirmed whether she will agree to further direct help for consumers,

It is rumoured that Truss wants to pass targeted payments to those most in need, while Sunak believes that help should be available to all to get on top of the issue at once before winter arrives.

The rise that has already been seen in consumer prices has seen real wages fall dramatically over recent months, and this will lead to inflation busting pay deals or significant industrial action. Strikes have already been taking place on the railways and postal services, with public sector workers about to be balloted about action.

The recent strike by council workers in Scotland brought a vivid reminder of what could happen in England, with rubbish piling up all over the country.

The investment community is beginning to abandon the UK as a safe opportunity as property prices are set to decline as the market reacts to higher interest rates. Homeowners fearful of having to pay far higher rates to fix their home loans even for twelve months are scrambling to find deals which are becoming ever scarcer.

There is an entire section of the market that never experienced the phenomenon of rising mortgage costs, with interest rates having been at historically low levels for a decade.

The fall in the value of Sterling has seen it reach a low of 1.1568 versus the dollar and 1.1545 versus the euro. While it will soon reach levels at which there will be natural buying interest from bargain hunters, the fall in Sterling will add to inflation concerns for the Bank of England. The Bank’s Governor, Andrew Bailey, has been conspicuous by his absence recently, having dropped a bombshell when delivering the Bank’s latest economic forecasts. It sees a fifteen-month recession and zero growth in 2023.

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USD – Vacancies always fall prior to unemployment increase

With the Federal Reserve still claiming to be data-driven, this week’s various reports on the state of the employment market, which culminate with the release of non-farm payrolls tomorrow, will have made interesting reading for members of the FOMC.

Former Treasury Secretary and current President of Harvard University Larry Summers believes that the series of rate hikes passed by the Central Bank recently is beginning to influence employment, despite the most recent data showing that over 500k new jobs were created in July.

The latest prediction for the August headline figure is for around 325k new jobs to have been created.

Summers believes that the JOLTS data for job openings which was published earlier this week is significant, since, historically, a fall in the number of vacancies often precedes a rise in unemployment, although there is a lag between the two datasets.

Summers also sees a soft landing as being less and less achievable as the Fed continues a path to driving interest rates deeper into restrictive territory. With at least a fifty-basis point hike a done deal for the next FOMC meeting in three weeks’ time and a better than fifty fifty chance that it will be seventy-five basis points.

There are only two meetings left this year after that, so short term interest rates could be two hundred basis points into restrictive territory by the end of the year.

A recession next year is still being predicted, and Jerome Powell is risking getting himself backed into a corner again, as he did about increasing inflation in the summer of 2021, when he called rising prices transitory.

If he continues to dismiss the views of eminent economists, and he is proved wrong again, his position may become untenable, particularly if the Democrats do as badly as has been predicted in the midterms which are fast approaching.

The President of the Cleveland Fed, Loretta Mester spoke yesterday of her expectation that the fed funds rate will reach 4%. This is the most hawkish view seen from an FOMC member.

She went on to say that she doesn’t expect to see any cut in rates at all in 2023. Without acknowledging any possibility of a recession, she is still squarely in the Powell camp, and feels that growth will be somewhat below 2% next year.

The current strength of the dollar index may have a marginal dampening effect on the rate of inflation, but it is not as critical in the U.S. as it is in other G7 nations, given the dollar’s almost universal use as a reserve currency.

Yesterday, the Greenback rose to a high of 109.12 and closed at 109.10.

Technically, the index appears to be experiencing difficulty in moving past 109.20 and may be prone to a correction before it is able to garner sufficient momentum to reach the 110 level.

EUR – Single currency waiting for Central Banks

The market appears confused about what to do with the euro now that it has reached, and tested the water, below parity with the dollar. It now seems prone to the market adage that it is too low to sell and too high to buy. In other words, both bulls and bears are looking for better levels to enter the market.

With the ECB lagging the Fed and Bank of England in terms of tightening monetary policy, the expectation of interest rates rising could supply a degree of support.

However, the next couple of ECB meetings, the first of which takes place a week from today, will be fraught with dangers for the economy. It is expected that interest rates will be hiked by fifty basis points next week. That will push official rates into positive territory for the first time since before the Pandemic.

Rates are by no means in restrictive territory yet, and the more hawkish members of the ECB’s General Council will want to see them close to that level, if they are to have any positive effect in bringing down inflation, which is now approaching 10%.

In a further blow to the economy, Russia again turned off the tap supplying gas to Western Europe yesterday. While this is only seen as temporary, more of a symbolic demonstration by Moscow of its power to disrupt the Eurozone economy, it will have sent shivers both figuratively and literally through several European capitals.

Europe has been hit by several natural disasters this summer, with drought having followed devastating floods in Germany, while fires have raged across France.

In her first interview for some time, ECB President Christine Lagarde was inequitable in blaming climate change for the disasters and vowed to provide as much support as the Bank can give to ensure that climate change is slowed if it cannot be reversed.

Given the current energy situation with Germany, especially, increasingly reliant on cleaner gas driven electricity production, a recent comment from a Minister that Germany will have to revert to burning wood, will have been most unwelcome, no matter how much it was delivered tongue in cheek.

With the euro reaching something of a hiatus, its next move could be dependent on the outcome of next week’s ECB meeting.

Yesterday, it reached 1.0079 with stop losses situated above 1.0080 being protected and fell back to close at 1.0053.