27 July 2022: Bailey promoting fifty basis points

GBP – Inflation remains priority as economy teeters

It now seems certain that the Bank of England will raise short term interest rates by fifty basis points when its Monetary Policy Committee meets next week.

The Bank’s Governor, Andrew Bailey, has spoken recently of prioritizing the Bank’s reaction to the various threats to the economy.

In keeping with other G7 Central Banks, the Bank of England sees inflation, whatever its cause, as being the most pressing issue.

Rising energy prices continue to be a significant contributor to the cost-of-living crisis, with the price cap on gas prices set to be increased again in the autumn.

It has been a feature of the cost-of-living crisis that is sweeping the nation that consumers are looking to the Government for assistance, which has traditionally not been the case.

While support was both considered unique and necessary during the Coronavirus Pandemic, then Chancellor Sunak has created a dangerous precedent for the country’s finances, which has seen the low paid and those on benefits look to the Government for aid.

While this would be the reaction of a socialist Government, it goes against the principles of low taxation and private investment that are a cornerstone of the current Administration.

Current Foreign Secretary Liz Truss appears to have opened a significant lead over former Chancellor of the Exchequer Rishi Sunak, the race to replace Boris Johnson as Prime Minister.

Her attacks on Sunak’s privileged upbringing seem to have struck a chord with Conservative Party members, who believe that the leadership has become out of touch with the man in the street.

This feeling has been exacerbated by Johnson’s flouting of the rules during lockdown and the emergence of the catch-all question do you know the price of a pint of milk?

The ability of travellers and commercial vehicles to cross from the UK this summer has been seriously affected by delays at the most used crossings, although France denies that it is acting precipitously in insisting on conforming to the letter of the post-Brexit regulations.

The New Cabinet will be forced to confront the continued high level of antipathy between London and Brussels if the country is indeed to reap the benefits of its escape from Brussels’ red tape.

The financial markets have descended into a summer lull currently, with even Central bank actions becoming predictable. Ranges have shrunk, with no new drivers to encourage volatility.

The pound traded between 1.2090 and 1.1963 yesterday, and closed at 1.2025 as long-standing orders limited any potential breakout.

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USD – Fed expected to hike by seventy-five basis points

It has always been considered a risky undertaking to either second guess the Fed or consider its actions to have become predictable.

In the past, Chairmen of the FOMC like Volker, Greenspan and Bernanke have been considered innovators who have used the markets to further the policies that have used to meet the Central Bank’s employment and growth targets.

Current Fed Chairman Jerome Powell is burdened by neither history nor blue sky thinking. He and his colleagues on the FOMC have been a little late in forming and executing their plans to tackle inflation using traditional methods, despite their issues not being rooted within traditional areas of the economy.

Since any economy is a continually evolving beast, innovation must play a part, although Central Bank’s the world over appear to be the last to consider globalization.

In the past, developed economies were nicely bordered, and this allowed Central Banks to use monetary policy to control excessive growth or downturns in the economy without difficulty. It was easy to control demand by hiking interest rates or support it by lowering rates.

While it was true, up to a point, that when America sneezes the world caught a cold, but now it has emerged that the same is true of China and as is being seen in Europe, Russia as well.

The Powell run Fed has become enslaved by the premise that to control inflation interest rates have to rise, but in the post-Covid world supply is equally important, which would have by now become the focus of a Greenspan or Bernanke FOMC.

Later today, a further seventy-five basis points will be added to short term interest rates and what has long been the neutral rate will have been achieved.

The potential to shake the market out of its current lull will come first from the Fed’s economic bulletin and then Jerome Powell’s press conference.

If the bulletin points to the Fed feeling that it is getting on top of inflation or Powell mentions easing back on the fate at which rates are rising, he may grab the attention of the markets.

However, since there is a natural break about to take place with the FOMC not meeting again until mid/late September, he may decide to say little and let events take their course, since the committee will have the benefit of seeing two releases of Inflation, employment, and activity data before another decision is necessary.

For now, the dollar index is managing to find support at lower levels, but for now lacks any upward momentum.

Yesterday, it managed to climb to a high of 107.28, and managed to cling onto its gains, closing just four pips from the high.

EUR – Energy driven recession to last through the winter

Bleak!

That is about the only word that can be used to describe the outlook for the Eurozone, as its members collapse one by one into recession and raging inflation is fuelled by Russia’s action in slowing to a trickle the level of its gas exports to the region.

Against this backdrop, the ECB has decided that the time has come for tighter monetary policy to contain the level of inflation, which to a large degree is being driven by events outside its control.

Only history will tell if the Central Bank was overly cautious in its continued support of its weakest economies, which were slow to emerge from the Coronavirus Pandemic. That caution has now led the stronger economies of Germany, The Netherlands, Belgium, and Austria to the brink of recession.

The new tool that has been introduced to limit spreads being paid by the more indebted economies of the Eurozone will be rendered ineffective, almost redundant, should the spread being paid by the stronger economies begins to rise.

As the Pandemic took hold in Europe, there was a real feeling growing of every man for himself, as Brussels botched the delivery of vaccines and European Commission President, Ursula von der Leyen acted in a singularly unpresidential manner by panicking herself into adopting a siege mentality.

Christine Lagarde is sufficiently experienced to be able to cope with the demands that are about to be placed upon the Eurozone economy, but the question is more around priority.

There was a tongue in cheek comment made recently by a senior German Politician that Germans may be forced to burn wood this winter since it is the only commodity that will be in plentiful supply within its borders.

As already mentioned, global inflation is based around globalization and the developed world has allowed itself to be drawn in by China, where sneezes are now far more serious.

It is impossible for the west to make a distinction about what is happening in China. Is it part of its global hegemony or a series of unfortunate events that have led the global economy to its current state?

The Eurozone has become dependent on energy from Russia and foodstuffs from Ukraine and its own inflation issues are rooted in a need for the conflict to end sooner rather than later.

Brussels won’t want to be dragged any further into the conflict, but the Determination of President Zelensky to fight on without giving an inch may see the war continue for a significant period.

The euro is still directionless, although it has a bias towards the downside. Yesterday, it fell to a low of 1.0107, closing at 1,0117 as risk appetite also weakened.