20 June 2023: Bank of England is losing the battle with rising inflation

The Government confirmed yesterday that having provided support for businesses trying to cope with Brexit and families dealing with the issues created by the Pandemic, there will not be any backing provided for those currently struggling or facing significantly higher mortgage payments soon.

While lenders have removed hundreds of mortgage products from their “shelves” as uncertainty dominates the market, interest rates continue to rise.

Although there is a link to the Bank of England’s continual hiking of interest rates, the reason that the mortgage market is so affected is due to the lack of clarity over when rates stabilize.

The cost of a typical two-year fixed mortgage is now above 6% when eighteen months ago when thousands of fixed-rate loans were repriced, they were at, or below 2%.

There will be no support offered to borrowers in the form of stamp duty “holidays”, or other measures as were seen during the pandemic.

Several economists believe that the lack of clarity or advance guidance from the Governor of the Bank of England has worsened the problem, and this has increased the risks of Central Bank policy being responsible for pushing the economy towards a recession.

The latest inflation data is due for release tomorrow, and while prices are expected to have fallen again, the fall is expected to be moderate and certainly not enough to encourage the Bank of England to pause its current cycle of interest rate rises when it votes on Thursday.

The Chancellor is on record as saying that the Bank of England has his full support, since he too sees little alternative to continued rate hikes as inflation proves stubborn.

There have been a number of issues that have gone away over the past few months. The wholesale price of energy has fallen considerably, while the forecourt price of unleaded petrol has stabilized, while the price of diesel fuel has dropped to below the price of unleaded.

Both the Federal Reserve and ECB have been more forthcoming in supplying advantage guidance, while Andrew Bailey continues to agree twenty-five basis point increases in rates. It is almost as if he believed that if the hikes remain relatively small, no one will notice. Unfortunately, the market has now reached a tipping point, and there is sure to be a knock-on effect that vibrates right through the wider housing market.

It is certain that rates will be hiked by twenty-five basis points on Thursday, but the significance of the post-meeting press conference will be greater than the effect of yet another hike.

Or maybe not!

Sterling continues to gain strength from the probable divergence of interest rates between the UK and the U.S., although yesterday it “paused for breath”. It fell to a low of 1.2770 and closed at 1.2791.

Jerome Powell will begin his six-monthly testimony before an increasingly twitchy Congress tomorrow with concerns growing that the economy may not escape a recession, even if it is relatively short-lived.

It is probable that Powell will be asked if he is prepared to allow the economy to contract to gain control of inflation.

It is believed that by most measures, interest rates are now at a level where they are restricting demand and an extended period of no change in rates would be preferable to another hike, or two, which may need to be rapidly reversed should the economy “head south”.

Both Powell and a number of his colleagues on the FOMC have strenuously denied that the cycle of hikes has ended despite the recent falls in headline inflation. Core inflation is still uncomfortably high with the service sector suffering from “secondary effects”.

The pause in the cycle of hikes that have taken place for ten meetings in a row will likely need to be for at least another meeting for the effect to see the economy “catch up”, but the market is pricing in another twenty-five basis points in July already.

The words used in Powell’s statement following last week’s meeting certainly give the impression of a one-meeting pause. He commented that “the FOMC has covered a lot of ground already and the full effect has not been fully felt, although there may be some further inflationary considerations caused by the still “hot” employment market.

There is still some time before the June Employment report is published and that, as well as the minutes of last week’s meeting, will have a significant bearing on the outcome of the July 25/26 meeting.

Several FOMC members are scheduled to make speeches this week and will likely be asked about their commitment to the pause in rate hikes. Their replies are likely to have a significant effect on the dollar index.

Yesterday the index began to rebuild after its FOMC-driven precipitous fall last week. It rose to a high of 102.55 and closed at 102.50 as it created further space above the 101.30 support.

Isabel Schnabel, the German economist and member of the ECB’s rate-setting Governing Council, confirmed her palace as an interest rotate hawk yesterday as she commented in a speech that she believes that the Central Bank may have to go further than what is already expected by the market in order to bring inflation, which she labelled “runaway”, under control.

She waded into the developing row over a September hike. Although there has been no official comment over whether the ECB will pause, or indeed end, its programme of rate hikes after its July meeting, the more hawkish members of the Governing Council maintain that a September hike may be justified.

Schnabel believes that the ECB must “risk erring on the side of doing too much on rates”. With the economy already in recession and interest rates at or remarkably close to being restrictive on demand, her view is certain to create a high level of angst in Madrid, Rome and Lisbon.

An alternative view was offered by Philip Lane, the Central Bank’s chief Economist, who rebuffed talk of a September hike commenting that there is no need to commit to a September hike even if a July one is already pencilled in.

These comments lay bare a widening divide between the doves and hawks on the committee which is unlikely to change in the coming months. Lane’s point is valid given that there is a significant opportunity for inflation to fall in the coming months, which may afford both sides a degree of breathing space.

With a recession already affecting most, if not all, the members of the Union, it would be a perilous decision to risk a further contraction by taking interest rates further into restrictive territory.

Economic data is being barely considered now as market practitioners believe that everything is pointing to a difficult H2, with the ECB at risk of sacrificing growth on the altar of reducing inflation.

There are growing fears that Europe will slip further and further behind the U.S. as America presses forward while the EU remains mired in a narrow view of its issues.

The common currency lost a little ground yesterday, falling to a low of 1.0907 and closing at 1.0922.

Have a great day!