Market expects hike, sterling on the edge

Tackling inflation remains the number one priority for the Bank of England’s Monetary Policy Committee, since it was forced to accept that rising prices were unlikely to return to the Bank’s 2% target without changes to monetary policy.

Bank of England Governor Andrew Bailey was one of several central bankers who jumped on the bandwagon of labelling rising inflation as transitory and that it would return to acceptable levels once the logjam in supply chains had abated.

The continued rise in the wholesale price of gas, exacerbated by tensions around Russia’s border with Ukraine, and global shortages of microchips have been major contributors to rising inflation. This week, the MPC will have a decision to make that was expected to be relatively easy before the New Year.

Rate hikes at consecutive meetings were, and in many; observer’s minds, remain the likely outcome of the meeting on Thursday. This would be the first time in eighteen years that the Bank of England has hiked at consecutive meetings.

However, various headwinds are growing that could easily blow the nascent recovery off course.

Boris Johnson and his Chancellor, Rishi Sunak, both confirmed over the weekend that the increase in National Insurance contributions announced in Sunak’s budget last November would indeed come into force in April.

It had been rumoured that as part of his survival strategy, Johnson had been pressuring Sunak to delay the implementation of the rise to buy some time.

Johnson’s survival should be decided this week, as the delay in delivery of the Cabinet Office report on various parties at 10 Downing Street is expected to be released.

Sue Gray, the compiler of the report, is reported to have informed Scotland Yard, which is also investigating the events of the contents of the report.

It could easily be that before the Bank announces its decision, the country could be looking for a new Prime Minister.

This could be a significant week for the pound. Its medium-term fate lies primarily in the hands of Andrew Bailey and his colleagues, but short-term, the result of the inquiry will raise the political risk around the currency.

Johnson, seen as the man who delivered the stunning landslide election win a little over two years ago, may now be considered too much of a liability to lead his Party into the next.

Last week, the pound suffered at the hands of a strengthening dollar but was able to maintain recent strength versus the euro. It fell to a low of 1.3357, closing at 1.3396. Versus the euro, it reached 1.2041, closing at 1.2015.

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Microchip shortages hit most sectors

As mentioned above, global shortages of microchips are one of the common yet serious concerns facing supply chains as the global economy struggles to recover from the Coronavirus pandemic.

The Federal Reserve has been ramping up its fight against rising inflation since Its President Jerome Powell, about to start his second term, announced that it was time to retire the term transitory to describe rising inflation.

It will be for historians to determine if Powell hung on to the hope that inflation would calm on its own for too long. It could be that if the FOMC had become more hawkish earlier that it could have cut off the recovery before it got going.

At its meeting last week, the Chairman came close to guaranteeing that there would be a rate hike at the meeting which takes place on 15/16 March. The burning question for investors now is, could that hike be of fifty basis points.

Rises of such magnitude were commonplace in the nineties but have fallen out of fashion.

Were that to be the case, it would virtually confirm the dollar as a one-way bet, but as has been said many times, Central banks retain the ability to surprise markets when they become so one-sided.

This week, the January Employment reprint will be released. Early predictions for Friday’s headline non-farm payrolls are for 200k new jobs to have been created. This is a conservative estimate given what has been expected, but failed to be delivered, over the past quarter.

Before the Employment report, data for manufacturing output for January will be released. This is expected to fall marginally from 58.7 to 57.5. While this will be disappointing, output still remains well into positive territory.

Jobless claims and services output will follow on Thursday. Jobless claims appear to be likely to average around 250k or possibly a little lower for the next few weeks as the market settles down. Services output will most likely correct from December’s surprisingly high reading of 62, possibly falling to around 58.

The dollar broke through a number of resistance points following the FOMC meeting and the threat of a 50bp hike in March will see it remain on the front-foot.

Last week it hit a high of 97.44, closing at 97.21.

Hawks set to push for tighter policy

This week’s ECB meeting could be pivotal in both how Monetary Policy in the Eurozone will develop this year, as well as having a major effect on the fate of the euro.

ECB President Christine Lagarde will expect to face a barrage of criticism over the way she has virtually ignored rising inflation throughout the region while maintaining extraordinary levels of support for the economy.

New Bundesbank President Joachim Nagel has been fairly reserved in his comments about inflation since he took office. But is expected to release the full force of Germany’s inflation concerns at the meeting.

Germany itself is struggling to return to the position it held both economically and politically within the Eurozone until recently. Not requiring the support that other nations have received, it has suffered more with rising inflation due to the ECB keeping interest rates in negative territory.

Its influence was damaged by the fact that it was unable to halt or reverse the decision to change the Central Bank’s inflation policy from a firm level of 2% to a vaguer target close to 2% and to use its average as a measure.

Having been well below 2% for a considerable time, prices were allowed to rise almost unfettered by any verbal intervention.

Lagarde remains committed to continued support, and there is undoubtedly going to be some tough negotiations before that level of support from March onwards is agreed.

Data for Q4 GDP is due for release later this morning. It is expected that it was virtually flat quarter on quarter, and rose by 4.7% year-on-year, an improvement on the 3.9% figure at the end of Q3.

The euro suffered badly at the hands of the dollar last week. Breaking through the 1.1250 level, it fell to a low of 1.1121, closing at 1.1150.