2 November 2022: BoE unlikely to spring a surprise

GBP – Market expects seventy-five basis points

The Bank of England has begun to reverse its programme of quantitative easing, which began in 2009 when the country faced a deep recession and banks were not lending to each other. Under the programme, they purchased Government Bonds from financial institutions which provided liquidity to the market.

This drove interest rates to historic lows and encouraged businesses to continue to borrow money to fund expansion and speed recovery.

The BoE sold a relatively small number of bonds, valued at around £750 million, out of its stock of around £850 billion.

The UK is the first G7 nation to begin to withdraw support.

There have been calls for Sunak to extend the windfall tax on energy companies that he introduced when he was Chancellor of the Exchequer, as BP announced its third quarter profits yesterday.

The energy giant made profits of just over £7.1 billion, more than double what it made in the same period last year. As the oil price has risen, so have the profits of oil companies, sparking claims of profiteering.

The most serious complaint is that firms like BP are quick to raise the price to consumers, but slow to reverse the rise as prices fall.

The Central Bank will announce the result of its most recent deliberations over interest rates today. It is expected that it will hike rates by the largest amount for 33 years. A hike of seventy-five basis points will take the base rate to 3%, still low by the standards of the nineties, but high enough that the housing market will see its first fall in prices in 15 months.

Housing is disproportionately affected by interest rates increases and if often monitored for signs of a possible recession.

Despite the rise in interest rates that began last December, it is the mini-budget that was published during Liz Truss’s brief time as Prime Minister that has been blamed for the fall.

Higher borrowing costs, when added to the rise in household staples, have put significant pressure on family’s budgets. The market slowed significantly last month, but still managed to show an increase.

The Pound was a little higher in quiet reading as traders awaited the announcement from the Bank of England regarding interest rates.

It rose to a high of 1.1566 and closed a 1.1483.

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USD – Federal Reserve accused of ruining employment market

The US economy continues to slow down, but officials at the Federal Reserve still believe that it can avoid a recession. Data released yesterday showed that output fell to 50 from 50.8 last month, continuing the trend of lower activity.

Later today, the FOMC will agree to another rate hike of seventy-five basis points. It is expected that when the minutes of this meeting are released in six weeks’ time, they will show a healthy discussion between hawks and doves – some calling for a slowdown in the Fed’s tightening of policy, and others demanding that it be halted altogether.

Jerome Powell, the Chairman of the Federal Reserve, is inclined to continue to hike rates as the Central Bank battles higher prices, for which he takes at least some of the blame.

The continued rise in inflation has at least three major elements: First, the volume of support that the Administration pumped into the economy during the Pandemic. Second, the war in Ukraine and Russia’s pressure on OPEC to cut production. Third, the Fed’s delay in introducing tighter monetary policy.

Powell takes personal responsibility for the delay, as he commented that rising prices were transitory and would settle down as supply chains returned to normal. This led to the Federal Reserve being about six months late in introducing tighter monetary policy.

The result of the FOMC meeting later may shed some light on the October Employment report, which is due for release this Friday.

There is no doubt that Fed Members will have had sight of an advance copy and as Powell continues to confirm that the Central bank is data-driven, were the result of the FOMC to be a little more dovish than market predictions it could mean that the headline jobs data is a little lower than expectations.

The Dollar Index was treading water yesterday as the market awaited the result of the FOMC. It traded between 111.70 and 110.75, and closed just two pips lower at 111.56.

EUR – North and South risk being torn apart

Over most of the history of the Eurozone, the wealthier nations of the North have been at loggerheads with the more radical nations of the South over the latter’s profligacy, and lack of fiscal discipline.

At the time of the financial crisis, Angela Merkel made it perfectly clear that Greece, in particular, was running the risk of being cast adrift from the rest of the region if it didn’t regain control of its public spending.

The other nations whose budget deficits were close to 3% or whose debt to GDP ratios were close to one hundred appeared to take notice, but the arrival of the pandemic has seen them return to their old ways, while Greece has become something of a paragon of financial discipline.

Spain and Italy would be facing tough measures from Brussels if Germany were able to flex its financial muscles, but it faces two issues that prevent it from being able to exercise its authority.

The first is that its own economy is barely growing at all and is likely to fall into recession early in the New Year. The second issue facing the Eurozone’s strongest economy is the war in Ukraine, which is a constant threat to its security.

The more indebted nations have a majority on the Governing Council of the ECB now, and this led to the Central bank providing far greater levels of support than was considered prudent.

The decision to tighten monetary policy was only taken belatedly against a backdrop of protest, despite inflation breaking double figures recently.

Southern members are more accustomed to high inflation, high interest rates, and ‘boom or bust’ economics than the more reserved countries like Germany and Austria.

With inflation continuing to rise uncontrolled, the ECB will need to tighten rates considerably if the North is going to regain the degree of control. The alternative could be disastrous.

The Euro managed to remain above support at 0.9850 yesterday. It fell to a low of 0.9852, closing at 0.9883.