Bailey joins the transitory team

Bank of England Governor, Andrew Bailey, has joined in with his colleagues from other G7 Central Banks in downplaying the long-term effect of rising inflation on the country’s economy as the UK emerges from the Coronavirus pandemic.

When weighed against a tightening of monetary policy which could cut off the recovery almost as soon as it has begun, inflation is being blamed on transitory as opposed to structural factors and is expected to even out as both the UK economy and those of its largest trading partners reach a degree of equilibrium.

As has been seen in the aftermath of recent FOMC meetings and the release of their minutes, commentators, traders, analysts, and investors are clamouring to understand the tools that Bailey has at his disposal to tackle inflation should it begin to rise at a wholly unexpected pace

Never before has there been such concerted support and stimulus pumped into the economy.

It could be that the concerns are over-exaggerated given the similar furore that accompanied the introduction of QE, but while those concerns were, to a degree, theoretical, the nature of measures like the stamp duty holiday on house purchases are almost designed to be inflationary.

There has obviously been a great deal of conversation at the MPC regarding when the support is tapered, and outgoing Chief Economist Andrew Haldane voted to lower the level of bond purchases at the latest meeting.

Last week’s release of data brought the matter to the forefront of the market’s mind with core inflation rising to 1.5% more than doubling from the previous month.

The employment report showed that there could in fact be a labour shortage on the horizon as hospitality venues struggle to find employees. It was reported over the weekend that several restaurant chains are offering significant incentives to both find and then employ staff.

The pound continues to be well supported versus the dollar, although part of its recent gain is due to dollar weakness.

Last week, it reached a high of 1.4233, closing at 1.4149.

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A gradual rise followed by a more rapid fall likely

Two questions are emerging around the rise in inflation in the global economy, but more specifically what the Fed plans to do.

The first question surrounds just how serious the rise in inflation will be. Very few commentators have seen rampant inflation develop in a major economy and even fewer traders have seen the value of their investments be decimated by interest rate increases to try to deal with uncontrolled price increases.

The second question is more structural. Does it really matter what the cause of the inflation is? And how high it will rise and for how long will it remain a factor.

Jerome Powell continues to call the rise in inflation transitory. He has been joined in that view by both Christine Lagarde and Andrew Bailey.

While it has been accepted by the FOMC that inflation is certain to be the outcome of the Biden Plan, just telling the market that it understands its concerns is beginning to wear a little thin.

It emerged that the minutes of the most recent FOMC meeting that were released last week did little more than acknowledge what was already known but no plan was suggested or agreed regarding what the Fed intends to do.

Analysts have constantly criticized the ECB for sitting on its hands while the Pandemic has ravaged its economy, but this now seems to be a growing policy choice. As Central Banks are faced with policy choices the outcome of which is uncertain, they prefer to adopt a wait and see stance.

The most salient comments from the FOMC this week have been that officials now see a gradual rise in inflation over the rest of the year rather than one significant jump followed by a plateau, then a gradual fall.

Current thinking is that the more along the lines of a gradual rise followed fairly quickly by a rapid return to levels seen over the most recent past.

This belief stems from the fact that countries will emerge from the Pandemic at differing paces but as they all return to normal, the bottlenecks in manufacturing and supply will recede quickly and pent-up demand will dissipate.

Following a jump in reaction to the Fed minutes, the dollar resumed its downtrend last week. The index fell to a low of 89.64, closing at 90.02.

Not yet ready for post recovery discussions

Remaining true to her style of leadership, ECB President Christine Lagarde does not feel comfortable discussing post-Pandemic considerations while the economy is far from out of the woods.

Last week she refused to consider the inflationary implications of the stimulus plans that are still being discussed at the EU Commission.

Most analysts believe that those implications will be less dramatic than is being seen in other G7 nations due to the manner in which the support has been delivered, the depth of the recession and the more gradual recovery that will take longer to reach a critical mass.

Were there to be major concerns about uncontrolled inflation, it is fairly certain that Germany in the shape of the Bundesbank would be at the forefront of those voicing concerns.

Data released last week shows that business growth rose by its highest amount in three years this month.

While this is an attention-grabbing headline, it must be remembered how low a base that growth is coming from. While it is a welcome improvement in trend, Lagarde remains concerned that growth is both patchy and subject to localized bumps in the road.

An acceleration in both delivery and take-up of the Coronavirus vaccine has also seen a strong rise in the services sector. This is ultimately more significant since services had been the most significantly hit over the past year with Brexit adding a degree of confusion to the mix.

With Purchasing managers Indices now well above the 50 level which marks the difference between contraction and expansion, the Eurozone can now begin to genuinely accept that the worst of the Pandemic is over.

However, the southern states that are reliant on tourism remain under a cloud as concerns from the UK Government about the spread of variants means that Spain in particular despite welcoming tourists from the UK remain in the red zone which means visitors will have to quarantine for up to ten days upon return from any vacation.

The euro remains in the thrall of the dollar. It rose to a high of 1.2245 last week, closing at 12180.