3 May 2023: Confidence is improving, but rates are still hurting

With inflation falling albeit too slowly for Andrew Bailey’s liking there is a growing belief that Rishi Sunak is the right man to lead the country’s recovery from the issues that to a certain extent have been self-inflicted.

Having achieved a workable agreement with Brussels that could see closer ties between the UK and EU, Sunak is trying hard to erase the circumstances that brought him to power.

He has put in place, in concert with Jeremy Hunt an economic policy that is expected, if given time to work, should lead the country back to some semblance of normality if not prosperity.

It is true to say that he contributed to the raging inflation that has gripped the country over the past eighteen months or so, by providing the support which, at the end of the day, saw the country get through the Pandemic.

He also was the first member of Boris Johnson’s Cabinet to resign in protest at his leadership.

The country now has a serious leader who commands respect and understands the importance, no matter what backbench Eurosceptic MPs believe, of forging ties with the European Union without the need to be tied up in Brussels’ bureaucracy.

Tomorrow is likely to see the nadir in the Conservative Party’s fortunes when the results of local elections are reported. Having lost over a thousand seats at their control of several councils at the 2019 polls this time could be even worse.

The population will be giving their view on the shambles of 2022 when the country was virtually ungoverned for the period between March and September.

Currently, Sunak’s popularity rating is above that of the leader of the Labour Party, Sir Keir Starmer, most surprisingly among working class voters. While it is likely to be a case of right man, wrong time for Sunak, he is likely to put up a far more effective fight in the 2025 General Election than could have been expected a year ago.

Yesterday, the Nationwide survey of house prices was published. It showed that there was a marginal improvement month on month despite the year-on-year data still showing a fall in prices over the longer term.

Prices rose by 0.5% in April after a fall of 0.7% in March. While this is only a very minimal improvement, it shows that gradually, the Government is beginning to drag the economy back from the brink, while the agreements that have been reached with both railway workers and NHS staff over pay should also improve both investor and consumer confidence.

Sterling gave up its gains from last week in a thin, holiday affected market on Monday and continued to suffer yesterday, falling to a low of 1.2435 versus the dollar. The collapse of another U.S. bank sent concerns through the market and contributed to a fall in risk appetite.

With the Fed and ECB meeting this week, the MPC is likely to continue to act in line with its G7 partners by hiking rates by twenty-five basis points. It may well be the end of tighter monetary policy but the statements from Jerome Powell, Christine Lagarde and Bailey will provide further clues to the market.

There remains a concern in the market that irrespective of the views of regional Fed Presidents, that Jerome Powell remains on a one-man crusade to bring inflation back to the Central Bank’s target of 2%.

While it is obvious that his ill-judged remarks last year regarding rising inflation being transitory and due in large part to the level of support that was pumped into the economy during the Pandemic, there were more crucial factors that sent inflation to its highest level in decades than the opinions of a single person, even if he is regarded as the most important Central Bank Head in the developed world.

Even as he was speaking, a perfect storm of the war in Ukraine, the rise in energy prices, and supply chain issues were brewing that was sure to blow the economy off course.

There is no doubt that there will be an inquest regarding the actions of the FOMC over the past year, where questions will be asked about whether the policy of hiking rates over a long period has been effective in providing a degree of stability.

Powell will no doubt be asked about whether it was more important to bring inflation down than to protect the economy from contracting to such a degree it faces a recession.

The failure of three banks has sent shock waves through the market, and it was only the actions of the Fed in bringing together several bank CEOs on Saturday to ensure that the assets of First Republic were sold to an organization that was well-prepared to integrate them into its own balance sheet while protecting the bank’s depositors that stabilized the market.

There could have been a bloodbath on Monday if the Fed hadn’t acted swiftly and decisively in staunching the wound.

The market is eagerly anticipating today’s FOMC meeting. Traders are growing tired of hearing that yet another week will be a watershed for the U.S. economy. It is true that after having hiked by a further twenty-five basis points that Jerome Powell may confirm that there will be a pause in rate hikes, he may simply hint at a change of policy to keep the market on its toes.

Then, this Friday the April employment report will be released. This was supposed to be the time when new job creation was to contract. While there is little doubt that the headline figure will continue its trend lower, no one is now predicting that it will be negative.

The Fed’s actions in calming the reaction to the First Republic crash have given it leeway to hike once more, but the reaction of the dollar may be unpredictable.

Yesterday the dollar index rallied to a high of 102.40 but traders and investors unsure of today’s events took profits on short-term long positions and this saw the index fall back to close at 101.95.

There are several commentators and economists who have become bullish about the likelihood of a soft landing for the Eurozone economy, perhaps overly so.

It is hard to say what a soft landing will even look like for the region given its highly diverse makeup.

By contrast in the U.S. it is fairly clear that if inflation is brought under control by cutting demand while employment remains positive, then a soft landing has taken place.

Employment, while important in the Eurozone as a factor in the strength, or otherwise, of the economy it is only one of several factors that are taken into consideration.

The EU is still in its infancy in relative terms and for this reason there has not been a definitive path that leads to economic stability created. There is also the issue that the region has stumbled from crisis to crisis since its creation, and it is constantly evolving whether that is by the addition of new members, or a radical change in political direction from individual members.

The leadership of the EU is both a political football and being diluted by the creation of so many committees and Commissioners with often overlapping responsibilities.

Its leadership is unable to be decisive in its decision-making in a way that other G7 nations have a single figure with his or her finger on the button.

The European Parliament is little more than an expensive talking shop with its members jealously guarding their own interests. Until MEPs come together with a feeling for the common good, Brussels will continue to struggle to exert control over the entire region.

It could be argued that political and monetary union was a step too far. It has been said that one of the main reasons for the creation of the EU was to create an environment where wars like it were seen in the last century could be consigned to the history books, but here we are with a war right on the doorstep, with no effective policy for how to deal with Russian aggression.

Rather than taking a lead, Brussels has looked to NATO for guidance when it should be at the forefront of a united reaction.

Tomorrow, the Governing Council of the ECB will meet to decide on further action to tighten even further monetary policy. While the hawks of the Frugal Five will push for a fifty point hike in interest rates, they will almost certainly agree to a compromise which will see short term rates rise by twenty-five points.

Christine Lagarde will be questioned about when a pause will take place but is likely to exercise all her diplomatic skills to dodge the question.

Yesterday, the euro had a mixed day. Initially, it fell to a low of 1.0942 threatening a medium term line of support, but bounced back strongly to end the day at 1.1002.

Have a great day!