30 May 2022: Economy hit by perfect storm

Brexit, Covid and global slowdown to have long term effect

The UK economy is facing severe storm clouds over the next few months as the Government continues to bury its head in the sand over the weakening economy.

The package of emergency measures introduced last week are a band over a bullet hole, and pay no heed to the additional increase in the energy cap that is set to be increased again in October.

Currently, the fuel cap is set just short of £2,000 but is set to be increased to £2,800 in early Autumn.

With a majority of close to 80 seats, Boris Johnson is bulletproof as long as he retains the support of his Parliamentary Party.

There have been some rumours of his losing some of that support as two further MPs declined the whip, leaving them to vote as they wish. If 54 MPs out of 360 submit letters expressing that they have no confidence in the Prime Minister, a vote will be held, with a simple majority upholding the decision.

Senior Conservatives still believe that Johnson is the man for the job, while it is the younger, more zealous MPs who believe the code of conduct has been broken.

Last week, data for activity in the economy was published. While manufacturing output was lower, the major concern for Q2 growth was the collapse of services output, which fell from 58.9 in April to 51.9 this month.

It is reasonably certain that, unless there is a major change, services activity will have contracted in June. Since this makes up 80% of GDP, the UK economy will be heading for a recession.

The Bank of England will now face a tough decision, it is impossible to imagine a Central Bank tightening rates with the economy contracting.

The pound fell following the release of the. It reached a low of 1.2471, but it recovered as the dollar continued to correct, closing at 1.2629.

This week sees no significant data releases in what will be a holiday shortened week.

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Economy won’t face another financial crisis

Data released recently predicts that the U.S. may face a mild recession, but it will not arrive in the short term and will not be so significant that the Fed is unable to reverse any contraction.

Recessions are considered by many to be disastrous for the economy, when in fact they are little more than a fact of life.

When looked at in detail, the 2020 Covid related recession was nothing of the sort, the single reason for the contraction was the effect of the Pandemic and the lockdowns that followed.

This leaves 2008, Which traumatized hundreds of thousands of people who lost their jobs and homes in the aftermath.

Economies, when they are performing well, create asset bubbles and these often burst, leading a section of the economy into contraction.

This fact of life rarely develops into a slowdown across the entire economy, and that is likely to be the outcome of what is going to happen towards the end of 2022.

A lot depends on the path of energy prices despite the U.S being almost immune domestically from price volatility.

Last week, data for new home sales was released, and it provided a fairly convincing argument for the first signs of a slowing economy. Inflation fell moderately in April, but the FOMC now has the bit between its teeth and will hike rates by fifty basis points twice more, which when added to the effect of the reduction in the Bank’s balance sheet, should see rates at least at a neutral level.

The Fed will then have the option to pause to understand the effect of its actions, or to hike more should inflation not be responding as expected.

Durable Goods Orders, which give an idea of future growth also fell in April, which may also feed into the Fed’s calculations.

Last week, the dollar index gave an indication that its recent correction is reaching its bottom.

It reached a low of 101.43 and closed at 101.63. This is close to a 50% retracement of its recent rise and should therefore attract some buying interest.

This week, the market may be a little thin with London closed for two days, but the May employment report may create a little volatility.

Early predictions see the NFP headline at around 200k new jobs created as job hopping begins to abate.

Decision time is fast approaching

Following tacit agreement that the ECB is going to hike rates at its July meeting, the argument about by how much they will hike is beginning.

The Central Bank’s Vice President, Luis de Guindos, when questioned about a fifty-basis point hike, commented that he preferred to stay neutral on this point.

The markets believe that he is against a hike of that magnitude given his Spanish background. Christine Lagarde has not commented yet on the size of the hike, but it is to be assumed that she believes that the first such action should be the minimum possible.

In a sign that borrowers fear a series of rate hikes, commencing with 50 BP, corporate lending in the region grew in the region in an effort to lock in low interest rates.

With the blackout period about to begin, ECB officials and Central Bank Heads took the opportunity to express their views, with hawks attempting to persuade their colleagues of the need to hike by an amount that will start to gain control over inflation.

With prices beginning to moderate in other G7 nations, the ECB still faces the issues being created by the conflict in Ukraine, particularly where energy and foodstuffs are concerned.

Last week, the IFO institute published its current and future expectations for the German economy. It sees current expectations as a little better than April, while future expectations are haunted by unknowns, although on balance they may improve slightly.

The Euro gained a little ground versus the dollar, rising to 1.0766 and closing at 1.0735. Resistance at 1.0820 may be tough to break, and it is doubtful that the single currency will be able to muster sufficient momentum to move above it.

This week, the final reading for consumer confidence is published, it is expected that it will be unchanged at -21, while industrial confidence falls marginally.