Risk appetite likely to fall as Central Banks consider taper

Next week’s MPC meeting will be crucial in the Bank’s plans to both support the economy and head off inflation that is continuing to rise, but at a slower pace.

While there will be no change to interest rates, which will continue to be held at a historically low level, the discussion about beginning the taper of asset purchases will be significant.

There have been several comments made by MPC members recently in which their position has either changed or softened. It remains to be seen whether the vote to retain the current level of purchases sees any votes against. If that were to happen, it would be a major signal to the market that the end of support for the economy is approaching.

The comments that have been made have so far ignored the inflation question. They have mainly been questioning the strength of the recovery, either saying that it is sufficiently robust to stand on its own or concerned that there are too many imponderables to take the chance of needing to reverse a decision in the Autumn.

There is growing speculation that the Chancellor is going to delay his budget until next year. While this will be jumped upon as yet more evidence of dithering, it does make perfect sense with the withdrawal of support now well under way.

The fiscal effect of the withdrawal of furlough payments will be difficult to judge as there are parts of the economy that have only survived due to its staff being paid by the Government.

Sunak will present the latest forecasts for both the economy and the fiscal state of play to Parliament on 27th October. The numbers will be produced by the Office for Budget Responsibility, independently of any forecasts from Sunak’s own department.

The summer lull is nearly upon us with a slight change this year. Since Central banks have held the market in a tight grip for several months and next week’s BoE meeting is the last for a while, currencies are likely to drift within their current ranges.

Risk appetite will take over as the main driver with Sterling reacting well to any improvement.

Yesterday, the pound rallied to a high of 1.3981, cloning at 1.3951. It remains to be seen whether there is sufficient momentum to take the pound through the 1.40 level versus the dollar.

It would be significant were this to happen before the MPC meets, but if there is a vote or two in favour of a reduction in asset purchases, then that momentum may take Sterling up to test resistance at 1.4012.

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Growth disappoints but economy still above pre-pandemic

Data for GDP growth between April and June was released yesterday and although it took the economy back above its pre-Pandemic level, it was something of a disappointment, missing the market’s expectation by some distance.

The economy grew by 6.5% in Q2, up from 6.3% in Q1. The market was expecting a rise of 8.5%, but it is hard to be too disappointed following such an increase.

With analysts expecting this to be the end of stellar numbers as the economy has continued to recover, but at a more sustainable pace and supply bottlenecks subsiding, Q3 may see both growth and inflation regularize somewhat.

Jerome Powell’s continued description of inflation as transitory will become the market’s mantra as well should there be a fall in inflation back towards the 4% level when the data is released in the coming weeks.

Despite a constant reference to CPI as the measure the market uses, the Fed prefers Personal Consumption Expenditures (PCE) which is a far more widely based number that captures a wider range of components.

Weekly jobless claims continue to fall, with the headline of new claims falling to 400k from 424k the week before. It now seems a long time since the market was waiting for claims to fall below 500k, and the four-week average is now 394.5k and continuing to fall.

Next week sees the release of the employment report for July. Market expectations at this early stage are for around 900k new jobs to have been created up from 850k last month. Investors will be keen to see as small an adjustment to the June data as possible, and this will be as important as the July headline.

The dollar index continues to suffer from the perceived dovish tone of the latest FOMC press conference, which confirms what has already been said about the effect of Central Banks on currency levels.

Yesterday, it fell to a low of 91.85, closing at 91.91. It could be on its way to a test of 91.50 as liquidity falls.

German inflation above 3%, mostly technical

The Bundesbank is unlikely to allow domestic inflation to rise much further following yesterday’s release of data showing that it rose to 3.1% this month, up from 2.1% in June and a market expectation of 2.8%.

While ether has been no official comment so far, you can bet that Jens Weidmann is looking at ways to reduce the level of price rises without being able to resort to monetary policy, which has been hijacked by EU doves.

It is also certain that the words patience and transitory are banned.

If you just look at the rise in fuel prices since the recovery began in earnest, it is fairly clear where the rise in inflation comes from.

German economists and Central bankers are concerned that if they appear to be blasé about inflation rising above 3% will they be able to contain public concern if the next data shows 3.5 or even 4%.

It seems that for now, Angela Merkel, Ursula von der Leyen and Weidmann are prepared to allow the ECB leeway as their current monetary policy decisions are designed around support for countries whose economies have been more severely ravaged by the effect of the Coronavirus, but as was seen in the treatment of several countries in the financial crisis when they snap back it will be with a vengeance.

Eurozone consumer confidence also weakened in the latest period as the public became more concerned about the effect of the Delta Variant and the slowing pace of vaccinations, although services sentiment improved markedly.

Individual data for Germany also showed that unemployment fell by 91k in June and the rate fell to 5.7% from 5.9%.

The euro continues to march towards a test of 1.20 versus the dollar, which would go some way to improving the outlook for inflation.

It reached a high of 1.1892 yesterday, closing at 1.1886.