Delay in taming inflation may have unacceptable cost

When the MPC voted against a hike in interest rates last November, it is doubtful that they realized that their decision would lead them to the position they find themselves in now.

Inflation is pretty much out of control now and consumers are facing a further cost of living rise in the coming weeks. The rising wholesale price of gas has its origins in several areas of the global economy and cannot be considered to be due to a single event.

However, the timing of the significant rise in national insurance contributions is the brainchild of the Chancellor and is part of his plan to begin to recoup some of the expenditures that were seen during the Pandemic.

It is also supposed to provide further funding for the NHS, but it is not clear where the funds will end up.

The Prime Minister is making efforts to move on from partygate, despite being hounded by the press to answer whether he will step down should he be found to have broken the law.

The levelling up agenda is being promoted, and to the Government’s credit it is a policy pledge that had been shelved since Coronavirus hit the country.

It is expected that the final piece of legislation will be removed in the next week or two that removes the need for self-isolation following a positive test.

This is another of Boris Johnson’s gambles or calculated risks. He wants the public to be mindful of Covid-19, which hasn’t gone away, but return to as close to a normal life as possible.

The pound received a boost on Friday from retail sales data which was far stronger than had been expected. Following a 4% fall in the previous month, sales rose by 1.9% MoM. This was also well above the market’s core expectation for a 1% increase.

The removal of most restrictions is also going to provide consumers with more confidence, despite the concerns driven by the coming cost of living increases.

The Bank of England faces a difficult choice at its next meeting. Will the hawks feel that a hike at a third consecutive meeting is justified with inflation continuing to be more than 2½ the Government’s target, or will the doves prevail believing that a wait and see approach would be more sensible? Either way, it is almost certain that the interest burden will continue to rise at least for the first half of the year.

Last week, Sterling showed signs of strength versus the dollar. It rose to a high of 1.3642 and closed at 1.3597. It is still in a wider 1.3690 -1.3420 range.

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FOMC members undecided on size of hike

It is hard not to form the opinion that the Russian President knows exactly what his plans are for the situation on Ukraine’s border and is toying with the West.

Putin and French President Macon held a telephone conversation yesterday, where it was agreed that they would continue to search for a peaceful settlement.

U.S, President Joe Biden has apparently agreed in principle to attend a summit meeting with President Putin. This has been proposed by France and looks like little more than an attempt by Macron to advance his qualities as a statesman.

It is becoming more obvious almost daily that Putin has an endgame in mind, and every nuance to his comments on the situation lead to that outcome.

The minutes of the January FOMC Meeting were released last week, and the most obvious takeaway from the meeting is that participants agree that rates should rise at a faster rate than was seen in the last cycle, in 2015.

While that could mean a fifty-basis point increase next month, it could also mean several consecutive twenty-five basis point rises.

Given the level of inflation and the Fed’s clear message that bringing it back under control is its most pressing goal, most observers believe that the former choice will be the outcome on March 16th.

Fed Chairman Jerome Powell will supply an update on the Fed’s outlook when he testifies before Congress next week. This will be his semi-annual report on the economic outlook.

Powell is still Chairman pro Tempore, since Congress has still confirmed neither him nor his proposed deputy, Lael Brainard.

The FED still faces a growing rise in wages that could still push inflation higher no matter what action the Central bank takes.

Chasing inflation higher by pressing harder on the brake may see the economy tilted into recession.

This week’s data releases include activity indexes released by Markit, consumer confidence and Q4 GDP.

Growth is expected to have reached 7% in Q4, up from the earlier prediction of 6.9%. However, with real wages in negative territory, which will be little cause for celebration.

The dollar index is receiving support from global tensions around Ukraine, but with the Fed not seeing the gain from diverging monetary policy decisions from G7 nations, it is still seeing downside pressure.

The index was unchanged at 96.10 having been in a tight range all week.

Lack of raw materials and spare parts hitting output

It seems that the situation regarding supply chains in the Eurozone differs between the official version and what is being seen on the ground.

This is probably another developing situation similar to the region-wide inflation data, which varies from country to country.

ECB President Christine Lagarde committed last week that she believes that there have been some significant improvements lately, but manufacturers and industrial businesses in many nations, particularly Germany, are still struggling with production.

Consumer confidence remains in negative territory. The data for January. It had been expected to rise to -8 but instead fell to -8.8. This barely registered on the currency since the geopolitical situation is of far more relevance currently.

However, the single currency continues to build a stock of negative numbers that will need to be considered by the ECB.

Lagarde has, for now, abandoned any hawkish comments since the situation in Ukraine could have major downside effects for the economy.

Were Putin to weaponize gas supplies, inflation would rise to such an extent that the Central Bank would be left with little choice but to act aggressively, and that would almost certainly see the economy tipped into recession.

Even now, commentators still see the ECB edging towards tighter monetary policy. There is a rising consideration that a hike could take place at the September meeting. There are of course several issues that make such a prediction almost impossible to judge. That date coincides with when asset purchases would end and would therefore be the natural conclusion of support.

ECB Economist Philip Lane has shifted his stance on inflation. He expects it to fall back to the ECB target over the next two years but is unlikely to go below the 2% level.

The two-year time horizon is an important indicator for the ECB. Only a few weeks ago, Lane was fairly confident that inflation would fall below target over the same horizon. This adds to any hawkish action that will be taken to bring it back to an acceptable level.

Last week, the euro fell marginally to close at 1.1324. It remains well above the pivotal level of 1.1250, but several commentators still see it falling back towards the 1.10 level in the medium term.