30 November 2022: Inflation unlikely to fall below 4%

Catherine Mann has been a member of the Bank of England’s Monetary Policy Committee for over a year now and has begun to flex her hawkish muscles. Over the past few meetings, she has voted for interest rates rises more than what has eventually been agreed.

Yesterday, she spoke of her fear that the Central Bank is losing its fight to bring down inflation to its 2% target. She spoke of her concern that the target that is set by the Government could become unattainable as the global moves into a new phase as the era of accommodative interest rates ended.

She sees that inflation is now becoming embedded in the UK economy, with the increasing level of industrial action threatening both fiscal and monetary stability.

There has been a significant increase in the level of inflation in the services sector. Pre-Covid, inflation in this area of the economy was running at well below 2%. It is now above 3%.

Mann was at the forefront of the call to initially front-load rate increases to get ahead of the threat of rising inflation. This was not considered a workable proposition since it could drive the economy into recession. Mann believed at the time that this was a risk worth taking, but her colleagues disagreed.

Now, the economy needs no help at all to slow down given the influences both from within and outside its own borders, while prices are continuing to rise.

It is understood that the makeup of the Monetary Policy Committee, which is the responsibility of the Treasury Select Committee, is under review with the goal of making it more reflective of the policies of the Government. Andrew Bailey believes that there are forces among Ministers that want to undermine the independence of the Central Bank.

A long-term study is underway that will review the Bank’s contribution to the stability of the economy since it was granted independence by Gordon Brown when he was Chancellor in 1997.

Andrew Bailey spoke yesterday of how he was not consulted by the Truss administration prior to the September budget, which caused chaos in the markets. Had he had a say in the proposed measures, he believes that the worst of the turmoil could have been avoided.

In a survey published yesterday, it was revealed that freedom from red tape is not a priority for business post-Brexit. In fact, 75% of SMEs are not following the Government’s plans.

The pound lost ground yesterday as the dollar was driven by the prospect of another jumbo rate hike taking place in December. It fell to a low of 1.1945 and closed at that level.

Members of the FOMC have begun to make their voting intentions at forthcoming meetings clear in the period immediately following the publication of the minutes of the earlier meeting.

By doing so, they can distance themselves from majority decisions that they may not have been in favour of. For example, James Bullard the St. Louis Fed President is in no donut that interest rates need to both increase further and the larger increments that have been a feature of the past three meetings need to continue.

Bullard feels that since the latest minutes, where there was a distinctly dovish tone to the Fed’s attitude to inflation, that the market has moved into dangerous territory by underestimating their intentions.

He backed his belief that rates need to continue to increase adding his feeling that the economy is unlikely to fall into recession, although he did concede in comments made yesterday that the economy is likely to see a period of sluggish growth.

Two further threats have emerged recently that may see the economy negatively affected. The first is the possibility of a rail strike. President Biden has urged congress to act by blocking the action by unions before the resumption of deadlocked talks.

He believes that the economy is delicately poised now and a rail strike could prove devastating. He went on to warn that without rail freight, many major industries would be forced to close before the Holidays. The current unrest in China could also feed into supply chains.

The current cooling-off period is a requirement of the Federal Government in the period immediately prior to a vote on strike action. Both sides have taken the opportunity to consult. Both the unions and the railway companies have been lobbying congress to elicit support for their side of the argument.

With the November Employment report just two days away, the markers are anxious to see if the latest FOMC action has had any effect in cooling the number of new jobs created. Anything above a headline of 200k will be seen as positive for the dollar index, which has regained stability since the minutes were released.

Yesterday, it rose to a high of 106.88 closing at 106.80. It is close to the bottom of its recent range and will see an increase in volatility should the NFP data be outside its recent range.

There is a growing difference of opinion beginning to grow between the ECB, or at least certain sections of the Governing Council, and the financial community.

Over the past few days, there have been hawkish comments from the President of the Central Bank and certain Central Bank Heads about the need for continued aggressive tightening of monetary policy to ensure that inflation is defeated.

Neither Christine Lagarde nor Robert Holzmann was able to see any change in price pressures.

A report issued by Deutsche Bank, which is agnostic about the direction of interest rates in the Eurozone, confirmed its opinion that the latest data shows that inflation is beginning to stabilize.

Since the prospect of higher interest rates is just about the only factor supporting the single currency, if the views of Germany’s most prominent bank are found to be correct it could have a profound effect on the currency.

Data released by both Spain and Germany yesterday shows that inflation is indeed slowing. In Germany, headline inflation fell from 11.6% to 11.3% in the latest reporting period, while in Spain it fell from 7.3% to 6.8%.

This is likely to reinforce the claims of the more indebted nations that a jumbo increase in interest rates is not called for.

The data, coming so close after Christine Lagarde’s increased belief that inflation is likely to rise again, creates a significant fracture in the Central bank’s supposed unity.

The fall in inflation was attributed to lower electricity prices and since the fall in the cost of energy has not been constant across the entire region, it may not contribute to a fall in Eurozone inflation.

It will be yet another nail in the coffin of Eurozone unity. The consistency of energy prices has been a topic of conversation for some time at Ecofin meetings, and several countries are calling for a central board to regulate both the supply and price of electricity.

The generation of power is created by so many sources that it is felt that to have one body could benefit everyone.

The euro is under pressure from the inflation data. Yesterday, it fell to a low of 1.0320 and closed at 1.0325. It is likely to remain weak for the rest of this week, and possibly until the Central Bank meetings have taken place.

Have a great day!