26 June 2023: Sunak asks mortgage holders to “hold their nerve”

The Prime Minister, in a TV interview yesterday, said that the people of the UK must “hold their collective nerve” in the face of continued high inflation. He went on to say that fighting inflation is the priority for the Bank of England, and the Government can do little to influence it other than supplying all the support it can.

Following its surprise fifty basis point hike in short-term interest rates last week, the market now believes that the Central Bank is taking rising prices seriously, having adopted a relatively low-key stance to the situation despite hiking rates consistently since December 2021.

Analysts believe that the peak for interest rates will now be 6%, and this will be reached by the end of the year, by way of two or three further hikes.

Kwasi Kwarteng, the Chancellor under Liz Truss’ disastrous, albeit belief spell as Prime Minister last year, spoke out at the weekend, criticizing his replacement, Jeremy Hunt, for almost welcoming the possibility of the country being plunged into a recession as the Bank continues to hike interest rates.

While a recession is considered the “nuclear option”, to drive inflation down towards the Government’s target, both Hunt and Andrew Bailey have considered the possibility publicly, although neither is likely to welcome a contraction, particularly since the economy is still below the level it was at the start of the Pandemic.

The May inflation report, which was published last week, left the Bank of England with little option but to show its determination to fight higher prices by doubling the size of its earlier twelve rate hikes.

There were concerns raised by the Chancellor last week that instead of passing on savings, as the cost of some essentials fall, to consumers, Supermarkets are choosing to maintain their profit margins. He believes that this is shown by their recording of record profits in recent months.

Sterling was bolstered by last week’s interest rate hikes, making new highs against the dollar and euro. Versus the Greenback, it reached a high of 1.2845 before falling back a little to close at 1.2715, while against the common currency, it reached 1.1740 and closed at 1.1671.

This week, GDP data for the past quarter will be released. This is expected to show that the economy grew by just 0.1% between January and March, leading to year-on-year growth of 0.2%.

In his testimony before Congress last week, Jerome Powell announced his confidence that a recession has been avoided, given the gradual, if the not buoyant state of the U.S. economy. The fear of a credit crunch that was considered possible, as three regional banks collapsed, has largely receded.

The Chairman of the Federal Reserve defended the decision to pause the cycle of interest rate hikes that was taken at the most recent meeting of the FOMC, commenting that it was prudent to allow the economy to “catch up” with rate hikes that have taken place so far.

When asked “why now”?” Powell retorted that only now has the committee felt that as energy prices stabilize, there is a better than even chance that headline inflation will follow.

He did, however, comment that this should not be considered as anything more than a pause and at next month’s meeting, the data will be further considered and that will likely lead to a resumption of hikes.

Powell went on to say that although inflation has been falling consistently over the past few months, the employment market still is a considerable risk with workers still finding sufficient new jobs to enable them to be confident of finding more highly paid jobs. This is continuing to fuel inflation.

The Secretary of State, Anthony Blinken, spoke over the weekend of the cracks that are appearing in the Putin administration after the extraordinary events that were seen in Moscow at the weekend. Although he will continue to watch events closely, it remains, for now, a domestic matter.

The dollar index initially suffered in the wake of the Fed’s pause but has recovered somewhat as the market believes that the comparative strength of the economy will continue to compare favourably with the rest of the G7.

The dollar index rose to a high of 103.16 and closed at 102.86.

This week, data on house prices and consumer confidence will be reported, as well as the Fed’s report on stress tests that have been performed on banks since the recent collapses.

The market is not expecting any key issues to be reported, and with a further week’s grace given the June employment report won’t be published until a week from Friday, the situation in Russia is likely to dominate.

The conversation over a potential rate hike at the ECB’s September meeting refuses to die down. The Bank’s Chief Economist tried to instil some order into the conversation by commenting last week that while it is likely that a hike will be agreed next month, “we cannot be considering ourselves to be data-dependent, if we are predetermining rate hikes based on what can only be largely out-of-date numbers.

Isabel Schnabel, the German economist and member of the Bank’s Governing Council, was determined to Stoke the fires of a September hike further by commenting that, in her opinion, it would be better for the Bank to overshoot what is considered to be a neutral interest rate since she expects rates to remain in restrictive territory for “some considerable time”.

Over the weekend, the main spokesperson for the dovish contingent reiterated that he feels that the ECB is on the final leg of rate hikes. While Luis de Guindos didn’t say it, it is clear that he believes that a pause following the July meeting would be prudent.

He used the same language as Jerome Powell to restate his belief that the entire Eurozone economy needs to be given time to catch up with the hikes that have taken place already.

The argument that it would benefit the economy for a pause in hikes to take place sooner rather than later was driven firmly home by data released last week that showed that the economy continues to suffer with output falling even further, while consumers see no end to rising prices.

The main argument for a continuation of rate hikes is the fact that core inflation remains consistent, and this is the main reason Christine Lagarde is still determined to continue the cycle of hikes.

Last week, the euro suffered as the situation in Russia became more worrying. The fact that there appears to be chaos within the Kremlin cannot lead to anything other than greater concern for several eurozone members who border the country.

The single currency fell to a low of 1.0844 and closed at 1.0893.

Have a great day!