Pay restraint is a non-Starter

Bank of England Governor Andrew Bailey has suffered from the exposure he has received as Central Banks return to the forefront of economic decision-making.

The post financial crisis period saw Central Banks move into the background as interest rates fell and inflation appeared to have been beaten.

That entire period of the cycle was ended by the Coronavirus Pandemic and the monetary and fiscal support that was needed to protect the economy from lasting damage.

Prior to the pandemic, many members of the public would have been hard-pressed to identify Bailey, such was his lack of publicity.

That has changed gradually, culminating first with his being accused of misleading markets over the possibility of a rate hike last November when he badly misjudged the mood of his Monetary Policy Committee.

That faux pas was forgiven since he was inexperienced in the effect his words could have on financial markets. At the December meeting his performance improved, but the level of mistrust remained despite the decision to hike rates being taken.

There was speculation about whether rates would rise for a second consecutive meeting, the first time that had been necessary for eighteen years, but Bailey kept his own counsel in the run-up to the meeting.

The decision to hike was made, and Bailey outlined the Bank’s new-found inflation fighting credentials at the subsequent press conference.

Unfortunately, for a man who earns a salary of close to £500k per year to try to ask workers not to demand pay rises that equal the rate of inflation was his let them eat cake moment.

Bailey is now being accused of being out of touch with the reality of what the man in the street is experiencing. While it will be difficult to bring inflation under control if a wage/price spiral begins, the burden of higher prices, tax increases and a global energy crisis should not be placed at worker’s feet.

Boris Johnson saw his support crumble further last week as a number of top-level advisers left their posts in protest of his participation in and then handling of the fallout from partygate.

It is rumoured that up to 100 MPs are primed to oppose Johnson in any confidence vote. In such a scenario, he would win a vote, but he would be severely wounded, possibly mortally.

The pound continues to find support from the Bank of England moving to a more hawkish stance, but it fell last week versus the euro as the ECB also turned hawkish.

Against the dollar, the pound reached a high of 1.3627, closing at 1.3530. Versus the single currency, it fell to a low of 1.1806, closing at 1.1812.

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Market surprised by NFP Headline

A spike in the number of infections of the Omicron Variant of the Covid-19 virus during January failed to have much of an effect on employment, as the economy added 467k new jobs.

An even more surprising statistic was the revision of the December headline from 199k to 510k. This is a startling change, and it takes away from the January figure.

If the market had been aware that the December figure was far stronger than the Bureau of Labor Statistics had announced, the expectations for the most recent data would have been considerably higher.

This serves to highlight the fact that it is almost impossible to take an immediate snapshot of an economy that is so enormous and diverse.

While adjustments are common, such a huge one is unusual in the extreme. The way the non-farm payrolls data is released, with what could be considered undue haste, relies on several estimates.

This means that the data must be taken at face value and if the headline is significantly below market estimates, as it was in December, there is no way of challenging the Bureau.

This week, data for the other leg of the Federal Reserve’s economic responsibility will be released. Headline CPI is expected to rise from 7% in December to 7.3% in January, while core inflation is expected to rise from 5.5% to 5.9%.

The markets will be looking at the rate of increase to see if there is any levelling off taking place yet.

The Federal Reserve, already committed to hiking rates at its next meeting, will use the data from last week and this to decide on the magnitude of the increase.

The Chairman of the Federal Reserve, Jerome Powell, became acting Chairman over the weekend. This allows him to continue to perform his duties, despite the fact that his term in office has expired and his nomination by President Biden to serve a second term is yet to be ratified by Congress.

Last week, the dollar almost retraced its entire gain from the previous week. The index fell to a low of 95.13 but began to rally following the NFP data and closed at 95.44.

More hawkish comments to support currency

The surprisingly hawkish tone from the ECB President Christine Lagarde following last week’s Central Bank meeting was mild by G7 standards. However, this represented a sea-change from her previous commitment to monetary policy remaining supportive until the Eurozone economy is demonstrably stronger.

Lagarde has been under pressure since she announced a major shift in the Bank’s treatment of inflation. The more hawkish Eurozone Central Banks were concerned that inflation was continued to rise, as it has, almost unfettered.

It is interesting to note that Lagarde and her advisers were not attempting to ignore inflation, in fact she has commented on her concern over rising prices several times. It was more a case of prioritizing, and she favours growth over price increases.

This goes against the ethos under which monetary union was presumed to have been created.

Germany, as the shining light of modern industrial and economic discipline, believed that its model should continue to be adhered to despite the abject failure of the one size fits all.

A year ago, it would have been unthinkable that inflation could have reached close to 5%. It would be fascinating to know how a pragmatic technocrat like Mario Draghi would have solved this puzzle.

He has, of course, moved on to try to repair the damage wreaked by the Pandemic on his home nation, leaving the more gregarious Lagarde to knit together the Eurozone into a more federal group

He has attempted to do this by giving greater power to each of the nineteen Eurozone members to create policy, a form of democracy that had been under threat as several nations had required bailing out.

In the case of Greece, one of the more profligate nations, its new-found financial discipline that tackled the issue of a bloated public sector appears to have worked. Greece announced last week that it will repay the final tranche of support it received during the financial crisis earlier than had been scheduled.

The more hawkish tone from the ECB provided support for the euro. It rose to a high of 1.1483 and closed at 1.1455 last week. While its recent weakness has been averted for now, it may be that if the Fed hikes by fifty basis points and the ECB turns a little more dovish again, the move towards 1.10 may return.