2 August 2022: BoE facing its toughest-ever decision

GBP – Recession probable no matter Bank’s rate decision

The UK has long been a magnet for foreign investment. Following Brexit and the Pandemic, funds are beginning to flow into the country again. Several banks are looking to reinstate real estate investment trusts that had become dormant when investors shied away due to Brexit uncertainty.

London is seeing renewed interest. Birmingham, which is undergoing regeneration as the host of the Commonwealth Games is in the spotlight. Manchester is also being seen as a significant investment opportunity.

As the race to be the new Prime Minister continues, Liz Truss continues to attract the support of former candidates. Nadeem Zahawi and Penny Morduant have now come off the fence and pledged their support for Truss.

A cynic may believe that they have now seen which way the wind is blowing and see their path to Cabinet post as being more certain under Truss.

Although recent forums have been undecided about whether the Bank of England should hike rates this week, it remains likely that the Monetary Policy Committee will raise short-term interest rates by fifty basis points to 1.75%.

Interest rates have been rising in the country since last December, but there has been little, if any, talk about what is the neutral rate. It must be that, having seen this many hikes, neutrality must be achieved soon.

A hike this week will provide a boost to the pound which is gradually moving away from the 1.20 level versus the dollar. It may also reach that level versus the euro, although the ECB will keep pace on rate hikes despite only having just started its own programme.

The pound climbed to a high of 1.2293 yesterday, but saw some selling interest emerge on the approach to 1.23 and fell back to close at 1.2249.

The UK continues to do well versus the G7 as far as output is concerned.

Yesterday’s manufacturing PMI showed a minor slip from 52.2 to 52.1, but output continues to expand while other nations are seeing a contraction.

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USD – Markets agree that rate hike should have begun sooner.

It’s official! The Federal Reserve should have begun to raise interest rates sooner than it did.

It has been agreed that the level of fiscal support provided by the Biden Administration was sufficient to allow the economy to grow, while the level of interest rates contributed to the level of inflation currently being seen in the country.

Now, the economy is technically in recession having seen two consecutive quarters of contraction. It will be interesting to see what the Treasury comes up with as a new definition. Will it be three quarters of contraction, or even a year?

This haggling over recession is immaterial. The economy is slowing, and inflation continues to rise despite short-term rates now at a neutral level.

The race towards globalization, which has seen the world divided between manufacturers and consumers, means that there is a far greater reliance on the ability of the manufacturers to deliver and the consumers to continue to spend.

Data released yesterday shows that manufacturing output in China contracted in July while non-manufacturing continued to expand, although non-manufacturing output is far less significant than it is in developed economies.

The U.S., particularly Republicans, does not accept any American reliance on other nations, particularly those who are potentially hostile. China likes to fly under the radar as far as geopolitical issues are concerned, and has gone along quietly expanding its influence in nations that can be seen as suppliers of raw materials.

There is a potentially significant issue brewing between China and the U.S. and Senate Majority Leader Nancy Pelosi is insisting on visiting Taipei.

An uneasy balance has existed between the two superpowers regarding Taiwan, and both governments are demanding caution from Pelosi.

The dollar remains pressured by the market’s uncertainty over the potential for the Fed to pause its programme of rate hikes. There have been no major speeches by FOMC members since last week’s meeting. Until there is, volatility will continue to be high.

The dollar index fell again yesterday. It has now finished lower on 10 of 12 sessions since it made a high of 109.28. It fell to a low of 105.24 yesterday and saw very little recovery, only reaching a close of 105.38.

EUR – Lagarde is a little hawkish, and a little dovish too.

Christine Lagarde is grappling with her view of economic theory as she tries to navigate a path that will lead the Eurozone back to economic growth, while not stoking the flames of inflation.

Now is not the time for planning for the future. Inflation remains at record levels and the economy is in the grip of Russia. Energy shortages will force Brussels to dilute some of the measures that have been taken in the wake of the invasion of Ukraine, which will anger President Zelensky and concern neighbouring nations, Poland in particular.

Some say the EU showed a high level of naivety in agreeing to Russian supply of gas, and to a lesser extent oil.

It was surely only a matter of time before Russian hegemony raised its head and left the EU in serious condition.

Italy has been a major concern for both Brussels and Frankfurt as it has attempted to emerge from the Pandemic.

Now, with Mario Draghi’s coalition having collapsed, the country faces an unexpected election next month. Political stability has never been a strong point in Italy, with its constitution engineered to ensure that there cannot be a single Party in charge which could lead to the rise of a dictator, which has happened before.

It is being anticipated that the victor in the election will be the Five Star Movement. This will mean that Italy has its first far-right Government since WWII.

That will send shockwaves through the rest of the EU and see Rome demand concessions from Brussels under the threat of another defection.

Italexit isn’t being considered as a serious option yet, but in the event of economic hardship, a right-wing majority in Rome may begin to consider the potential benefits of going it alone.

The euro remains in a state of flux, hemmed-in on both sides. There is awesome, rather optimistic buying interest below the 1.01 level, but sellers emerge around 1.0280. Yesterday, it rose to a high of 1.0275, closing at 1.0261.

It remains to be seen if it can build sufficient momentum to seriously challenge the resistance.