20 October 2023: Even if rates are close to their peak, the BoE doesn’t want a further pause

The data that has been published this week has been mixed at best. While there is unambiguous evidence of a weakening of the employment market which is one of the goals of tighter monetary policy, inflation appears to be becoming ingrained.

For the first time in more than two years, in fact, longer than the MPC has been raising interest rates, wages are growing at a faster rate than prices, although the rate of wage increases is beginning to fall.

There is little doubt that based purely on the data that has been released, there is no clear path for the Bank of England. Speeches from the Governor and the Chief Economist have both shown that they favour a further rate increase, which will be supported by Catherine Mann, the most hawkish of the independent members.

Swati Dhingra who holds an entirely opposite view not only wants another pause but wants the cycle of rate hike to end. It is interesting to note that having served for a year, Dhingra has never voted for a hike.

She believes that rate increases are not a “quick fix” and should be used more cautiously since it takes a significant amount of time for them to work their way into the economy.

That having been said, there is a level of impatience when inflation is rising, and wages are not keeping pace which makes it difficult for the Bank to “sit on its hands”.

A rate hike will also see consumer confidence fall. The initial shock of rising inflation has been tempered a little as mortgage rates have begun to fall albeit slowly, while the energy shock that was for a time threatening to be as big an issue as the Pandemic has largely gone away.

Consumer confidence is falling as public conviction that the Government is going to be able to turn things around before an election is held is faltering. There is unmistakable evidence that levels of taxation need to be cut to see confidence return.

While the jury is out about whether the country is headed for a recession, Germany seems to see the prospects for the economy more clearly. Deutsche Bank, in a report published this week, believes that the economy will grow by 0.5% this year, up from 0.3% in its earlier bulletin.

Also, the German Economy Minister lamented Brexit in a speech recently, declaring that in his view, the EU is weaker without the UK.

The pound was barely changed yesterday as uncertainty about the situation in the Middle East remained. It rose to a high of 1.2192 but ran out of steam and fell back to close at 1.2142.

Jerome Powell, the Chairman of the Federal Reserve is close to admitting defeat in his personal mission to tighten monetary policy to bring inflation down close to the Fed’s target of 2%.

It is common knowledge that Powell has been outvoted at the two meetings at which a pause in interest rate increases have been agreed, but he has not made his feelings known.

However, in his latest speech he has admitted that he finds himself at odds with several of his colleagues on the FOMC.

Despite this he keeps his hawkish outlook confirming that inflation, which appears to be becoming ingrained in the economy, is too high, and may require further interest rate hikes since it appears that rates are not yet curbing demand sufficiently.

The road to a soft landing for the economy is a tough one, strewn with many seemingly insurmountable obstacles.

The September employment report was a case in point. The economy produced an incredible 336k new jobs while the August number was also revised substantially higher.

While using personal consumption expenditures as his favoured measure of inflation, Powell believes that until the jobs market has cooled to an “acceptable level”, rates have not reached a restrictive phase and should be raised further.

This brings with it a further issue, since the market cannot get a confirmation of what Powell considers “an acceptable level”.

There are fewer economists, traders. investors or commentators who believe that the economy is heading for a recession, even if the FOMC adds another fifty basis points to the Fed Funds rate. Six per cent was one of the levels that was the likely peak, and little has changed to alter that view in the grand scheme.

The dollar lacks any impetus to break higher despite the risk aversion that is affecting the market due to the conflict in Israel and Gaza.

This may be yet another example of the changes that have been taking place in the market since the low interest rate era ended and the Pandemic illustrated the interconnection of the major economies.

The Greenback lost ground yesterday, retracing the gains it made on Wednesday. The index fell to a low of 105.95 but recovered to close at 106.22

The Governor of the Bank of Spain has reason to be heard when he speaks about the economy of both his own country and that of the wider Eurozone.

Not only is Spain predicted to have the best performing economy in the region both this year and next, but Spain is the first country to see its inflation rate fall to 2%.

It is almost as if Pablo Hernandez de Cos is performing alchemy as he presides over an economy that has exited the Pandemic and performing well.

Spanish politics has not always been the most stable, often rivalling Italy in its ability to perform a volte-face as the Government loses the confidence of the people.

Pablo Sanchez has been Prime Minister since 2018. His government retains its popularity which is a rare feat in Spain.

Sanchez has become embroiled in a row with Israel this week as some of his Ministers were accused of supporting Hamas. He appears to have used his considerable diplomatic and negotiating skills to defuse the situation.

Bank of Spain Governor, De Cos, is leading calls for the ECB to agree to a pause in its programme of rate increases at its meeting next week.

He feels that the insensitivity to the plight of indebted nations who are suffering a rout in the prices of their bonds sending borrowing rates close to “extortionate” levels will do harm in the long-term to the unity that is the cornerstone of monetary union.

De Cos went on to say that the ECB must take note of the global situation and what the sell-off in U.S. treasuries means for long-term borrowing rate generally.

He believes that the global situation may be sufficient to see inflation fall further without any more action on monetary policy, but the only way to know for sure would be to agree to a pause.

The ECB appears to be opposed to a single pause and may not be ready to declare the cycle of hikes at an end.

The euro rallied to a high of 1.0616 for no reason other than the market didn’t want to be long dollars. It subsequently closed at 1.0582 as a sense of equilibrium was restored.

Have a great day!