MPC certain to continue to defend against inflation

The Bank of England’s Monetary Policy Committee will meet at the end of next week, and it is highly likely that they will decide to hike interest rates for the second time in successive meetings.

The consequences of the committee’s relaxed attitude to ring inflation last year are now being felt throughout the economy. Andrew Bailey when asked about rising inflation was certain that the rise was transitory and would fade as soon as the economy was fully open again.

While Bailey was one of the more sanguine Central Bank Heads, the fact that once he had come to terms with the fact that inflation was not going away but actually continuing to rise, he was then accused of misleading the markets by pre-empting a vote. He was fairly certain that there would be a hike agreed at the November meeting, only for his colleagues to vote to maintain rates at 0.1%.

The fact that the Committee voted in Favour of a hike at the December meeting, the timing of which was unusual in itself underlined the fact that they got it wrong in November.

There is no doubt that the advent of the Omicron Variant of Coronavirus created uncertainty, particularly as the scientific community continually warned about its consequences.

Now it has become necessary for interest rates to rise three or even four more times this year.

It is expected that the hike on February 4th will be 25 basis points, and that will set the tone for the size of increase going forward.

As discussed on Friday, the economy faces several headwinds over the next couple of quarters. There is a growing feeling in the Cabinet that the rise in National Insurance contributions could be delayed. This would reduce the burden that households are going to face as the cap on energy bills is expected to rise significantly at the same time.

The country will begin to emerge, again, from the latest set of restrictions, labelled Plan B, as it becomes clear that Omicron hasn’t had the effect that had been feared.

There is also a real possibility that by the end of the week, the country could be looking for a new Prime Minister as the Committee set up to look into several parties held at 10 Downing Street during previous lockdowns is set to report.

Finally, preliminary data for services output in January will be published later this morning. It is expected to show a healthy increase, as the economy slowly recovers.

Last week, the pound was steady, in a range, versus the dollar. It reached a high of 1.3689 but fell back a little to close at 1.3553.

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This week’s FOMC meeting to continue hawkish backdrop

The first FOMC meeting of 2022 is expected to renew the hawkish tone that has been seen at the past two or three meetings. The Fed Funds Rate will be maintained at 0.25% while the removal of additional support will continue.

There will be as close a confirmation of a rate hike in March as Chairman Jerome Powell is able to give without completely overplaying his hand.

Major U.S. investment bank JP Morgan issued a report over the weekend in which it predicts a showdown in economic activity over the next few months. It also connected that the Fed has reached the Zenith of its hawkish comments and is now set to let its actions speak.

Speculations growing that the number of hikes being predicted in this cycle could be more than had previously been expected and could stretch well into next year.

The current consensus is for four hikes this year, but there could be two or three in 2023 as inflation hangs around longer.

On the flip side, employment remains a concern, but it is something of a mystery that is being driven by the continued rise in cases of Omicron. Jobless claims continue to rise, having reached a low of around 200k in the past few weeks. This is due to workers being concerned about the level of infections being seen at the workplace.

The average headline number for non-farm payrolls in the second half of last year was just over 500k. The past two have been less than half that number, which shows a significant slowdown in job creation in the fourth quarter.

This is a worrying trend for the FOMC and if it continues for this quarter, it could place them in a difficult spot, damned if they do and damned if they don’t.

It is worrying to say that Powell and his colleagues will be hoping that inflation begins to level off and the NFP regains some of the strength it showed in Q3, to allow it to normalize monetary policy.

Last week, the dollar began to regain a little composure following an almost month-long correction.

The index rose to a high of 95.86 and closed at 95.65.

Output data to show marginal fall

The continued fight against the Omicron Variant has led to a dampening of consumer confidence over the past month or so. As current conditions have weakened, there has been something of an improvement in the outlook for the next few months.

The hope is that the effect of the Omicron variant will fade, and this will improve the economic outlook.

Of course, the largest effect on the economic outlook will be provided by the ECB. Having had quite a gap since its last meeting, the doves and hawks of the Governing Council will cross swords again next week.

This will be the first meeting attended by the new Bundesbank President Joachim Nagel., He is likely to want to establish his credentials quickly, and although he may not be so outspoken as Jens Weidmann, he is sure to assume the position as the Captain of the hawkish team.

Christine Lagarde has had several weeks to establish her comeback on any calls for a tightening of monetary policy. Growth remains patchy. Some Eurozone members are continuing to struggle, while there have been some green shoots being seen in others.

The optimism expressed by French President Emmanuel Macron can be regarded as little more than electioneering, and his prediction of significant growth in the economy is little more than a dream.

Data for composite economic activity covering both services and manufacturing output will be released today. It is expected that activity will fall from 53.3 last month, to 52.6 in January.

While this is expected to be put down to the effect of Omicron and could be considered as positive, concerns remain that the economy is still not seeing the level of activity that the amount of support it is receiving warrants.

Tomorrow, the IFO report of the business climate in Germany will be released. Current expectations are predicted to remain unchanged at 943.7 while the climate is expected to have weakened, but only marginally. The risk for this report is hard to predict given the mixed numbers that have been seen recently for Germany.

Last week, the euro suffered a little at the hands of a slightly stronger dollar. It fell to a low of 1.1301 and closed at 1.1341. The major support at 1.1250 is back on the horizon, and a lot will depend on the FOMC meeting to say when it will be tested.