Outcomes from previous rate hike under scrutiny

The Bank of England will hold the first meeting this year of its Monetary Policy Committee next week. Until recently, it had been fairly certain that the second rate hike of the new cycle would take place, but the growing headwinds being faced by the economy have put that in jeopardy.

The continued rise in the wholesale price of gas is the single most significant issue. Many household bills are expected to double when the Government’s price cap is adjusted in April

As Boris Johnson awaits his fate to be decided by the report being prepared by Senior Civil Servant Sue Gray into activities in Downing Street during the first lockdown, he caused something of a stir yesterday by refusing to confirm that the rise in National Insurance contributions that is also due to start in April would, in fact, go ahead.

This is vintage Johnson, pulling a rabbit from the hat without having first discussed the notion with his cabinet colleagues.

The Business Secretary, Kwasi Kwarteng, speaking yesterday at the site of a third nuclear power station to be built on the Suffolk coast, confirmed to the press that there was to be no change to the Government’s plans to raise the basic rate of national Insurance contributions.

Following the haunted and almost defeated impression Johnson gave when appearing before MPs to apologize for his having mislead Parliament over what had truly occurred during various parties held at 10 Downing Street when the rest of the country had been under strict lockdown restrictions, he appears to have decided that if he is going down, he is going down fighting.

As the country emerged from Plan B restrictions yesterday, the number of infections of Coronavirus, the majority of which remain from the Omicron Variant, remains worryingly high.

The removal of the need to wear masks in shops and on public transport has received a mixed reaction.

There have been some localized rules kept in place in some areas, particularly around buses and trains, and they have been welcomed.

The pound has been driven lower versus the dollar as the market reacts to the continued hawkish actions of the Federal Reserve, which confirmed, following its meeting on Wednesday that it would hike interest rates at its next meeting, and surprisingly strong data for Q4 GDP. Sterling fell to a low of 1.3357 and closed at 1.3380. This was clearly a reaction to a more hawkish Fed, since versus the euro, the pound remains unchanged around the 1.20 level.

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Positive data makes the dollar soar

Following the continued hawkish comments emanating from the FOMC following its latest meeting, which ended on Wednesday evening, data was released yesterday that showed that the U.S. economy grew by 6.9% between October and December.

This was appreciably stronger than the market’s expectation of 5.5% and the Q3 figure of 2.3%.

Since the FOMC will have had access to an advance copy of the GDP figure, they clearly believe that Q3’s weak figure was a blip and that the economy will now be able to withstand the withdrawal of extraordinary support followed immediately by the beginning of a cycle of higher interest rates.

While Q4 is rapidly disappearing in the economic rear-view mirror, fresh data released yesterday for durable goods orders, data that contributes to predictions for future growth, was disappointing.

While this data is notoriously difficult to predict given the size of the makeup of individual contributors, the fact that orders fell by 0.9% following a rise of 3.2% in December and market expectations for a rise of around 1%.

Weekly jobless claims had been rising over the past few weeks but returned a lower figure for new claims yesterday. The headline figure fell to 260k from 290k the previous week, although the four-week average rose marginally.

One further piece of data that was released yesterday that may have contributed to Fed action was the Personal Consumption Expenditures for Q4. These rose quarter on quarter by 6.5% following a 5.3% rise in Q3. Core expenditures also rose over the same period.

Having broken through resistance at 95.20 and 96.20 the dollar index soared to a new 18 month high of 97.29 yesterday as the expected rise due either diverging monetary policy in the case of the Eurozone or a more certain path for interest rates in the case of the UK, propelled the index higher.

Next week will see the release of the January employment report. This has been weaker than expected recently as the workforce has shown no inclination to rush back given the Omicron variant and the view that jobs remain plentiful.

Weak household spending a serious consequence of prices

Long before the concept of the monetary Union was adopted, Germany was always the standard-bearer for economic activity. That concept has been severely dented by the way that the ECB president has wrestled control of monetary policy away from the theoretical control of the Bundesbank and German Finance Ministry.

The feeling that others would follow the path adopted by Germany was reinforced during the financial crisis when Angela Merkel insisted that countries should not simply be bailed out by the financially stronger nations but should pay a price.

Inflation has always been the prime concern of the ECB, even though in recent times it has not been able to reach its own target.

It may be that Christine Lagarde, in announcing that the treatment of inflation would be changed following a review of policy that concluded last August that the Central Bank’s target for inflation would be less strict, saw that the prioritization of growth and economic activity over price increases would face a significant challenge from thee Frugal Five.

The economy remains weak, with the IMF again downgrading its expectation for full year growth this week. The expiry of the latest round of support is looming, so Lagarde is going to be under pressure at next week’s ECB meeting to compromise. It is unlikely that monetary policy is going to be tightened any time soon, although data is beginning to show signs of bottoming out.

Inflation is continuing to rise and has caused a problem for some of the more moderate nations. The countries most in need of support are beginning to show signs of economic recovery, so Lagarde could be forced to agree to water down the next round of support.

The euro appears to have begun its fall towards long term support at 1.10 versus the dollar in earnest. The market is now convinced of the divergence of monetary policy, and this is only likely to be cemented following this week’s FOMC and next week’s gathering of the ECB Governing Council.

Yesterday, the euro fell to a low of 1.1132, closing at 1.1142.