26 May 2022: Sunak to deliver support soon

Fall in output may force Central Bank to moderate hikes

Boris Johnson looks likely to survive the publication of senior civil servant Sue Gray’s report on parties in Downing Street, which, he says, vindicates him and shows that he didn’t lie to Parliament.

There is a significant degree of ambiguity in the report, given that the leader of the opposition believes that the opposite is true and Johnson should resign to spare his Party any further embarrassment.

It is likely that Johnson will sign off on plans to support the lowest paid families who are struggling as the cost of living continues to soar.

The Chancellor is expected to act in the next few days to provide support with energy bills in particular as the announcement of a further hike in the domestic energy price cap in October will be confirmed. The cap was raised to just below £2,000 last month and will rise again to around £2,800 in October.

The economy is slowly grinding to a halt following the release of data on activity in the economy earlier this week. Fears are returning that the economy could face a period of stagflation and may actually already be experiencing it as inflation has reached 9% while data is predicting the beginning of a contraction.

The tailwind that the economy got from the reopening of the economy following extensive lockdowns during the Pandemic has now faded completely and been replaced by tailwinds created by soaring prices, supply delays, and staff shortages.

The effect of these factors is affecting households and companies alike.

Apart from a further hike in the energy cap, the country also faces issues caused by Brexit, further lockdowns in China, rising interests and the conflict in Ukraine.

These issues are beginning to bring concern to the Bank of England over its use of tighter monetary policy to combat inflation. Its Chief Economist spoke yesterday of the need for hikes to continue, despite the fear that they could lead the country into recession.

Month on month, inflation is likely to fall this month as April’s energy shock is absorbed into the data. However, year on year, inflation will continue to rise but not at the same pace as has been seen over the first two quarters of the year.

Pill added that fears that inflation will become self-sustaining through higher wages creating higher prices for consumers, which, in turn, leads to higher wage demands.

Yesterday, the pound rose moderately to again test resistance at 1.2590 but was unable to break higher and fell back to close at 1.2572.

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Advance guidance confirms further 50 bp hikes

Yesterday’s release of the minutes of the latest FOMC meeting, which took place on May 3rd and 4th, continued the Fed’s recent hawkish theme but failed to provide any further impetus to the long-standing belief that the Central Bank will hike by fifty basis points at the next two meetings as the fight to reduce inflation continues.

There are some observers who believe the moderating pace at which inflation is increasing may allow the Fed to slow the rate of hikes in order to reduce the fear that they could tip the economy into recession.

There was no mention in the minutes of either stagflation or recession, which although positive failed to reignite the dollar index which is threatening to test the 100 level as it continues to correct.

The minutes reaffirmed the belief that tightening monetary policy now will provide the Fed with the ability to review it again in the Autumn, when any slowdown will be at its peak.

While a degree of flexibility is a major bonus, many economists believe that the pace at which the economy continues to run bodes well for the rest of 2022, but they see any recession beginning in Q1 of 2023.

This week’s data for activity the economy was tepid, but was probably just about sufficient for it to survive a total of fifty basis points in hikes.

The criteria for a recession were never met by the decline created by the Pandemic given the relatively short period between the peak and trough, and Jerome Powell will not want to preside over a downturn that creates sufficient weakness in the economy to be termed a recession.

Data for durable goods orders, big ticket items like ships and aeroplanes, was released yesterday. This is a leading indicator of the potential strength, or otherwise, of the economy in the medium term.

Fears of a recession in 2023 were fuelled by the fact that the data showed a fall from 1.2% in March to 0.3% in April.

The dollar index gain bounced off support at 101.72 and managed to find its way back above 102 to close at 102.12.

Lagarde a dove in hawk’s clothing?

The ECB President, Christine Lagarde, is trying to convince the market that the fall in official Eurozone interest rates into negative territory was no more than an experiment. This would allow the Bank to pronounce it a success in the future and allow it to be used again.

There is no doubt that it will have been considered a success in some quarters, but that number won’t include pensioners or savers who have seen the funds significantly reduced.

While most market practitioners were concentrating on a hike in interest rates in July without really considering the actuarial rate of increase, suddenly it seems that a hike of fifty basis points has become the most likely outcome.

There has been no hawkish talk of front loading as has been seen in the U.S., while according to Dutch Central Bank Head, Klaas Knot, there will be no talk of reducing the size of the ECB’s balance sheet until next year at the earliest.

The rate at which the ECB makes changes to monetary policy is reminiscent of trying to rotate a supertanker through 180 degrees.

There are arcane and outdated mechanisms in place that hamper the degree of urgency that occasionally hampers any semblance of an agile policy decision-making.

The ECB Governing Council is still split between hawks and doves on monetary policy. The doves have held sway for some time, but it is the hawks that are in the driving seat now.

While any change won’t be considered a dovish hike, as has been seen in the UK, since Lagarde has been careful to ensure that the board’s members are not apologetic about the need for a normalization of interest rates.

There have been efforts from several officials, both technocrats and Central Bank Heads, to ensure that the public is convinced of the correctness of the decision.

Speaking at the World Economic Forum yesterday, Lagarde commented that she doesn’t believe that the ECB has been sufficiently influential in flexing its muscles, given its size and potential influence in the world economy. She is looking forward to the creation of a level playing field, as G Central banks normalize monetary policy.

The euro retained its recent degree of strength yesterday, although it is unlikely to have the momentum to break above the 1.08/1.0 area. It rose to a high of 1.0739 but fell back to close at 1.0686, fifty pips lower on the day.