31 January 2023: Recession to be unaffected by hikes

The IMF in a report published yesterday commented that it believes that the ongoing cost of living crisis will hit the UK harder than other major economies, and it will be the only country that ends the year with a smaller economy than it started with.

The cautious optimism that was seen over the past couple of weeks has evaporated. The IMF expects the economy to contract by 0.6% this year rather than grow very slightly.

Although these are not the words Jeremy Hunt wanted to hear, the Fund did also comment that following the Autumn Statement that the country is now on the right track to recover next year.

The Chancellor’s response to the report was to say that the UK had outperformed several forecasts made last year, and he remains optimistic.

The economy is not helped by the level of industrial action that is affecting the public sector. Yesterday, firefighters voted overwhelmingly in favour of strike action, while tomorrow sees the largest action for decades, with teachers and civil servants joining nurses and ambulance crews on strike.

One of the areas of the economy that is being badly hit is the housing market. Mortgage payers fall outside any support from the Government. The knock-on effect of a housing market slowdown is that it also affects the building trade, while higher mortgage payments affect consumer confidence and retail sales.

The Bank of England will raise short term interest rates at its meeting this week, with the permanent members voting for fifty basis points, while the independent members have very different views on the relationship between interest rates and inflation.

Yesterday, Sterling remained in the similar narrow range it has maintained for the past two weeks. It fell to a low of 1.2337 and closed at 1.2348. It is likely that the market will begin to see the effect of this week’s Central Bank meetings, and it will pick up as traders decide on medium term trends following monetary policy decisions and the comments that follow them.

In its World Economic Outlook published yesterday, the IMF also said that a significant slowdown in economic activity will mean that the rate of growth achieved by the U.S. in the fourth quarter is unlikely to be repeated this year.

It stopped short of predicting a recession, but said that it feels that the current level of new job creation is unsustainable given the slowdown in economic activity.

It is now widely expected that the FOMC will raise interest rates by twenty-five basis points at its latest meeting, which concludes tomorrow. Jerome Powell remains possibly the most hawkish member of the FOMC. His two deputies Richard Clarida and Lael Brainard are both taking a more pragmatic view of falling inflation, while the Regional Fed Presidents are becoming increasingly concerned by the slowdown they are witnessing around the country.

Today sees the release of house price and consumer data. House price rises are expected to continue to moderate. After a rise of 8.6% last month, a more moderate increase of 6.8% is expected this month. Consumer confidence remains weak, with household budgets squeezed by higher interest rates and petrol prices that, although they have fallen recently, are still well above long term averages.

Transcripts of tomorrow’s press conference will be pawed over by investors and traders in the hope of finding a clue to the employment data, which is due for release on Friday.

The market remains upbeat about the continued rise in the headline new jobs created, but are beginning to look beyond the headlines to try to spot potential weakness going forward. The headline is expected to be anything between 150k and 185k, depending on your view of how much demand has been dampened as interest rates enter a restrictive phase.

The unemployment rate, while at an all-time low, is likely to tick up from 3.5% to 3.6%.

Yesterday, the dollar index remained close to its six-month low, although traders are wary of second guessing the FOMC, having had their fingers burned before. Although twenty-five points is expected and would see the dollar possibly break its long term support, the Central Bank could just as easily surprise the market by remaining a little more hawkish for just a little longer.

The index rose to a high of 102.31 yesterday and closed at 102.23.

Christine Lagarde finds herself between a rock and a hard place. A fifty point hike in short-term interest rates is baked in for this week, but that will satisfy very few Central Banks around the Eurozone, nor will it satisfy their needs when it comes to inflation, economic activity and debt management.

The frugal five will point to the confidence and activity indices and say that tighter monetary policy is having a negligible effect, while ignoring the fact that short-term interest rates haven’t yet reached a level where they are restricting demand.

Of the three Central Bank meetings being held this week, The ECB is far and away the easiest to predict, not because fifty basis points is the most logical hike, it isn’t.

It is because fifty basis points is a compromise between the hawks and doves. This process is likely to continue for at least the next two meetings after this week as core inflation remains uncomfortable high even when discounting the exceptionally high rises in prices that are seen in the Baltic States.

Confidence is on the rise in the Eurozone, driven by an improvement in the German economy.

Following predictions of a deep and damaging recession in the Eurozone’s largest economy, data released yesterday showed that it grew by 1.1% year-on-year in the fourth quarter, marginally lower than the previous period.

Consumer confidence in the Eurozone was unchanged this month, while economic sentiment saw a more than 2% increase.

The effect on the euro of the result of the ECB meeting is largely dependent upon the actions of other Central Banks, in particular the Fed.

If the FOMC remains marginally dovish the euro may be able to hold above the 1.0940 resistance which opens up a test of 1.10.

Yesterday, the single currency fell to a low of 1.0839 and closed at 1.0845.

Have a great day!