24 March 2023: Base rate rises to 4.25%

Bank of England Governor, Andrew Bailey, gave an honest yet fairly upbeat speech in his press conference yesterday following the meeting of the Bank’s Monetary Policy Committee.

The base rate of interest was raised by a quarter of a percent to 4.25%. Bailey was cautious not to make any predictions when the Bank feels that it will be in a position to call a halt to tighter monetary policy.

While believing that the worst is behind the country, he feels that inflation may not have peaked yet, as evidenced by this week’s data which showed that the cost of basic foodstuffs continues to rise.

Headline inflation rose to 10.4% when the most recent data was released earlier in the week. Bailey feels that the committee has listened to the arguments from both sides of the discussion, yet made no promises about whether he feels the time is right for the bank to pause its fifteen-month fight with rising inflation.

The bank has been using traditional measures to fight a battle against inflation in an economy which is currently far from conventional.

No Governor has been faced with the task of creating monetary policy for an economy in which inflation is rising at over ten present annually, yet is also on the verge of a recession.

It would be glib to place the blame for both drivers on the war in Ukraine although the monumental raise in energy prices, which has now receded to below pre-war levels has been a major factor, while the level of production of grain that comes from Ukraine has been significantly underestimated.

Bailey has struggled with his credibility during what has undoubtedly been a difficult period for the Central Bank.

The liquidity issues being faced by the financial sector claimed its first casualty yesterday.

Amigo Holdings, a subprime lender, failed to achieve the optimal level in its capital raising efforts, citing a lack of investor interest. For that reason, its board of directors advised the market that it would try to wind down its activities in an orderly manner.

Amigo lost 79% of their value even before the announcement was made.

In his speech, Bailey said that he believes that regulation of the financial sector is adequate, but the UK still faces raised volatility which could still make it vulnerable.

The pound remains well-supported as the market comes to terms with increased volatility. It tested the 1.23 area versus the dollar yesterday, closing at 1.2283.

While Jerome Powell gave little indication of the Fed’s next move in interest rates, the market now feels that an end to tighter monetary policy is imminent.

Powell insists that the Central Bank remains data driven and that although inflation is moving in the right direction when viewed on a three-month time horizon, it is still subject to shock when volatile items that are subject to global events are included.

The release of preliminary PMIs today will give an early indication of output in both the manufacturing and services sectors. While employment is the go-to measure of the strength of the economy, several FOMC members are using PMI data to assess the strength of the economy in their particular regions.

Although the Treasury performs stress tests regularly on banks of all sizes in the U.S., it is only when genuine turmoil affects the market that banks’ true liquidity position is placed under a microscope.

Often, financial institutions are loath to ask for help in such market conditions for fear that they will attract unwanted attention that will adversely affect their stock price. A falling stock valuation can be difficult to halt and can place an otherwise healthy bank in severe jeopardy.

Banks have a difficult juggling act to perform to ensure that they have sufficient liquidity to deal with day to day business, but ensure that they maximize profit without leaving client deposits idle.

Janet Yellen’s statement earlier in the week that the Treasury is not considering extending its guarantee to all deposits with banks added to the concerns, and a number of CFOs will have taken a far greater interest in where their surplus funds are held.

Yesterday’s release of jobless claims data, which is a proxy for lay-offs within the market, showed that employment remains strong. The weekly figure declined to 191k. As a rule of thumb, anything below 200k is now considered positive which in excess of 200k is an amber, if not red, warning.

The dollar index remains close to support, but until there is a definitive decision regarding the path of short-term interest rates, it is unlikely to see much more of a decline. It closed yesterday at 102.65. The first level of support is around 102.30.

Although Christine Lagarde remains a convert to the hawks on the ECB’s Governing Council, she hasn’t abandoned her dovish tendencies completely.

Since the ECB hiked interest rates by fifty basis points last week, Lagarde has been more coy than she has been in recent times about the possibility of any further tightening of monetary policy.

Recent history tells us that in times of severe stress in the financial markets, the ECB has often been wanting in terms of regulation. In truth, given that the twenty members of the Eurozone each have a Central bank that has primary regulatory responsibility for banks in their own Country, the ECB is often dealing with either second hand or out of date information.

For this reason, its President often feels the need to be guarded in statements about the strength of the entire system, despite significant improvements that have been seen since 2008.

It is difficult to imagine that the ECB will go from being the most hawkish Central bank in the G7 to deciding that it has done enough to bring inflation under control over a period of a month.

For that reason, the market still expects another hike at the next meeting, although it is also hoping that there will be something similar to a timetable considered when the ECB expects to be able to begin to taper hikes.

Although the ECB was late to the party when it came to starting to tighten monetary policy, the fact that the BoE and Fed as well as the ECB are a considerable way down the road already, means that it is natural for investors to begin to considered when each will call a halt.

The euro has so far been the most obvious beneficiary of the heightened tension in the market. This is unusual and is a testament to the vast improvements in liquidity that have been achieved over the last 5–10 years. No longer are traders almost expecting the next disaster to involve a Eurozone nation.

The single currency appears to be running into selling pressure as it approaches resistance at around 1.0920. Yesterday it struggled to reach 1.09, although it closed at 1.0835.

Every day it remains above 1.0820, affords it a better cache of a further attempt at the 1.10 level.

Have a great day!