Output in the economy improving for now

The Prime Minister announced in the House of Commons yesterday that from this Thursday, those who receive a positive test for Coronavirus will no longer need to self-isolate. He introduced a package entitled Learning to live with Covid. This will allow the country to return to normal.

This announcement was not received with 100% agreement. There was a lot of doubt expressed by opposition MPs. Scientists are concerned that withdrawing free Covid tests at the current time will affect the old and vulnerable, while support workers already struggling with low wages may be forced to forgo testing themselves.

The only positive note came from the business leaders group the Confederation of British Industry, which welcomed the move to allow businesses to fully recover from two years of real difficulty.

Johnson will chair a COBRA meeting this morning where the current situation in Ukraine will be discussed. With Vladimir Putin moving to recognize the sovereignty of two breakaway regions of Ukraine that are controlled by Russian-backed separatists, Putin now has a legitimate reason to advance his troops into those areas, ostensibly on a peacekeeping mission.

This is a dangerous escalation of the situation and brings armed conflict even closer.

Data released yesterday for output and activity in the UK economy showed that the fading of the Omicron variant has allowed the economy to begin a revival.

Both manufacturing and services output saw significant increases. One of the most radical improvements came as virus related supply issues began to wane. If this improvement continues, the Bank of England will be more encouraged to tighten monetary policy to bring inflation under control, since the threat of tipping the economy into recession will fade.

Commentators are split over the prospects for Sterling going forward.

There is a view that a test of resistance at 1.3650 is imminent, while economists at HSBC see the pound as vulnerable.

They expect Sterling to weaken overall in 2022, but in the near term, they see the Bank of England disappointing traders by pulling back from being sufficiently courageous to hike by 50bp at the March meeting.

Yesterday, the pound reached a high of 1.3638, but ran into selling pressure and fell back to close at 1.3602.

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Fed facing an impossible choice

Concerns are growing amongst analysts in the U.S. that aggressive action by the Federal Reserve beginning at its meeting next month will be far from easing off the accelerator, and more a stamp on the brake.

Senior economists believe that the Fed may have left it too late to begin to tighten monetary policy and could cause severe damage this year.

While the question of supporting the economy or tackling inflation was up in the air, there was a split between those commentators who were hawkish in their outlook and the more dovish view. The split was close to 50/50 so gave the FOMC little guidance.

Regional Fed Presidents have gradually become more hawkish as inflation has reached 7.5% across the entire country.

One of the most feared economic outcomes is stagflation, where the economy begins to contract, but inflation continues to rise.

In the current environment, almost the entire cause of inflation is on the supply side of the economy, wages are rising, but the more significant claims are yet to come, and this is a potential game-changer.

Add to that the fact that those returning to work are demanding, and in many cases receiving, higher wages than were being paid pre-Pandemic.

With speculation growing that the FOMC will agree to a 50BP hike and some Regional Presidents calling for 100bp before June, the situation is going to require very careful handling.

Jerome Powell will supply his update on the economy in testimony to congress next week, and he is going to face some tough questioning. How his testimony is perceived may speed up, or possibly kill, his confirmation for another term.

While the issue of his confirmation is mostly a political manoeuvre, how Congress perceives the appointment of Lael Brainard as Powell’s deputy with specific responsibility for oversight could be vital.

The dollar index is under the almost complete control of Fed policy. It has been trading in a narrow range as the FOMC makes up its mind about the size of the coming rate increase.

Yesterday, it fell to a low of 95.69, but recovered to close a little higher on the day at 96.12.

Producer prices rise by 25%

Data for Producer Prices in Germany was released yesterday. This is a prime indicator of future consumer inflation, as it shows how wholesale prices are rising at the factory gate.

Although last month’s data showed a 24.5% increase., the fact that prices rose by 25% in January marks a significant milestone.

Month on month, producer prices rose by 2% which marks a fall from the December level but will cause concern at the Bundesbank and will harden the resolve of new President Joachim Nagel to fight for tighter monetary policy at the next ECB meeting.

Data for services output in Germany was also released and showed a significant increase from 52.2 in January to 56.6 this month. Output is still well into positive territory. Manufacturing output slipped a little from 59.8 to 58.5. The composite data was stronger, rising from 53.8 to 56.2.

Data for the entire Eurozone was similarly mixed. Since composite indexes rose, it is likely that the relaxation of restrictions that has begun in certain countries of the Eurozone is beginning to have a positive effect.

While individual data sets are important, the ECB continues to study the trend. However, in the current environment, it is the geopolitical situation that is the main driver of sentiment and investment.

The announcement overnight that two regions of Ukraine are now under the effective control of Moscow will not be well received by the financial markets.

The single currency fell late yesterday as it became likely that Putin would announce the recognition of Donetsk and Luhansk, as self-decreed People’s Republics.

That fall continued overnight, reaching 1.1388 so far.

The EU continues to be considered the main victim should there be any increase in hostilities, given its proximity to any conflict and the expectation that it will be expected to take a major part in any sanctions against Russia.

The ECB will have to take the situation in Ukraine into account in any new monetary policy decisions, and this is likely to favour the doves, despite the continued rise in inflation.