5 May 2023: Inflation to grow as the UK dodges recession

The composite Purchasing Managers Index which shows the output for the manufacturing and services sectors combined climbed further away from contraction last month, reaching 54.9 after a reading of 53.9 in March.

This places the threat of a recession firmly in the rearview mirror for the Government and should allow the Bank of England to continue to concentrate on bringing inflation down, closer to its target of 2%.

The Monetary Policy Committee meets next week with a decision on short-term interest rates to be announced on Thursday.

The PMIs are becoming a further economic indicator for analysts and the data for the construction sector will be published later this morning.

The expectation is for the sector to stay in expansive territory, but the data reflect the difficulties in this sector which is a vital component of the nascent recovery that the economy is experiencing.

So many areas of the economy that are considered vital for growth are used to compile the construction PMI.

Two new trade deals were signed yesterday with countries that will be a boost for the economy: Australia and New Zealand. Although both countries are members of the newly formed Progressive Trans-Pacific Partnership, having an independent tariff-free agreement with both nations will encourage two-way trade with the UK expected to be able to export both service and tech to both countries.

This will enable Australia, in particular, to become slightly more independent of the influence of China.

While counting continues in the local government elections that took place yesterday, the Conservative Party has not been routed so far as many in the cabinet had feared although the Labour Party has made advances in gaining control of some key councils.

The turnout in local elections is often low, and the Government fears that its supporters may choose not to vote as a protest against the shenanigans of the past year that saw Partygate and the country governed by three Prime Ministers.

Sterling reacted to the slightly dovish statement by the Chairman of the Federal Reserve following its latest rate hike. Yesterday it rose to a high of 1.2598 and closed at 1.2573. The pound is now trading at its highest level against the dollar since June last year and looks set to challenge long-term resistance at 1.2660.

The last time it was at this level was immediately before its virtual collapse to a low of 1.0339 when the market reacted with fear and concern over then Chancellor Kwasi Kwarteng’s ill-advised mini budget.

What goes up must come down is a truism that is often applied to the financial markets. However, it is very often a case of when?

The Federal Reserve signalled a pause to its year-long programme of rate hikes following its meeting on Wednesday. Jerome Powell spoke of giving things within the economy time to settle down.

It has long been said that inflation is trailing the interest rate hikes and a pause may be just what is needed to see how effective the Central Bank has been in tightening monetary policy in order to slow demand and, by doing so, bring inflation under control.

There are still lingering fears about the health of the financial sector, while a credit crunch, where access to credit across all tiger sectors of the economy, banking, business and household becomes difficult.

It is believed that a severe credit crunch would have the same effect as adding a full one per cent to interest rates.

Despite several comments from economists and senior bankers that the move from the FOMC is both correct and timely, the dollar index weakened further yesterday.

It fell to a low of 101.02 but bounced off support at 101. to finish the day at 101.43.

Later today the April employment report will be released. Although other data for the jobs sector is only loosely correlated with the non-farm payrolls, it is unusual for them to move in the opposite direction. For that reason, those brave enough to make a prediction, see the April headline being lower than March, possibly around 150k new jobs created.

Even if the Fed turns its pause into a permanent end to rate hikes, it is not believed that they will be in a position to cut rates before the second quarter of next year, given the inflationary pressures that remain.

Next week, sees the release of inflation data for April. It is not considered likely that prices will have fallen to such a degree that inflation will be significantly lower than the 5.6% seen in March. In fact, there may be a minimal rise in the headline figure.

The Governing Council of the ECB surprised no one yesterday by adding twenty-five basis points to official rates bringing the base lending rate to 3.25%.

The Bank is now entering what may be considered dangerous territory since rates have not been this high for a number of years, if at all, with the average from 1998 to date being 1.72%.

Christine Lagarde was content to take on a slightly hawkish stance considering the fact that Greece has been congratulated recently for its economic house in order, while Portugal, Spain, and Italy saw above-trend growth in the first quarter of the year.

She signalled that the ECB hasn’t yet in a position to consider halting or even pausing its programme of rate hikes. Although official rates are now well above their historical average, there is no way of knowing yet if they are restricting demand. It seems that only time will tell.

In her press conference following the rate decision yesterday, Lagarde’s comments were unusually hawkish. He said the Central Bank still has more ground to cover and a discussion of when the hikes will be paused hasn’t even been considered yet.

It has been said by economists that the switch from fifty to twenty-five basis point hikes may be a signal albeit inadvertent that the peak is not far away.

Eurozone inflation rose for the first time in months last month which means the core is far from under control despite the fall in the headline caused predominantly by lower energy prices.

Lagarde acknowledged that there were several votes for a larger increase of fifty basis points, as there was a feeling that inflation had remained too high for too long, and this was considered even more damaging to the economy than a shallow recession.

Traders took Lagarde’s comments with something of a pinch of salt believing that the ECB won’t continue to hike rates far beyond the end of the current quarter. The euro weakened in the wake of the announcement, falling to a low of 1.0988 and closing at 1.1012.

It still doesn’t seem able to definitively move away from the 1.10 lever which appears to be acting as something of a magnet in the short term.

Next week, investor confidence data is due for release on Monday, while German inflation data is due for release on Wednesday.

Have a great day!