BoE to keep market guessing

Bank of England Governor, Andrew Bailey, intends to continue to provide markets with advance guidance of the Bank’s thinking, despite the fact that that information may not always be reliable.

Bailey believes that any advance guidance given to the market should be considered to be subject to the caveat that such guidance is only valid if the economy is moving in the direction that the Bank expects.

Using that model, to understand last week’s decision to keep interest rates on hold for longer should be interpreted to mean that the economy is not growing as the Bank had expected, and it has therefore decided to prioritize growth over inflation.

Bailey was back on the wires yesterday for the first time since the Bank jolted markets with a notable change of direction.

Although he still believes that inflation remains transitory, he commented that the Bank will have to act by tightening monetary policy should rising inflation begin to spill over into wage demands.

The main concern is for inflation, which is currently limited to just the supply side of the economy, becomes generalized.

The withdrawal of the additional £20 per week bonus payment in universal credit continues to draw criticism, since many families had come to rely on it. Former Labour Leader Gordon Brown has labelled it divisive, despite the change in payment now being linked to those who are working and receiving the benefit.

The change to the benefit means that anyone working and receiving Universal Credit will be receiving an additional sum worth on average £20 per week. This fits in with a change in policy that hasn’t been widely advertised, that encourages people to look for work.

The pound recovered a little yesterday from its significant fall on Friday, following the Central Bank’s lack of action on monetary policy. Versus the dollar, it reached a high of 1.3579, closing at 1.3562. It is unlikely that the recovery will extend much further, given the headwinds created by continuing sleaze allegations and the threat of a trade war with the EU over the Northern Ireland protocol.

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Powell believes taper will halt rampant inflation

Jerome Powell, in a speech yesterday, was keen to emphasize the fact that the Fed has given itself a degree of flexibility regarding a rise in interest rates that will allow it to decide reactively to continued rising inflation.

Several commentators believe that the Fed has allowed itself to fall behind the curve by allowing inflation to spiral without acting to nip it in the bud.

Others, however, believe that as the economy begins to emerge from the Coronavirus Pandemic that tolerance of higher inflation is a price worth paying.

A number of Powell’s FOMC colleagues have also re-emerged to provide some reasoning about the Fed’s view on the economy going forward.

Deputy Chairman Richard Clarida spoke yesterday of the Fed’s benchmarks for an interest rate hike being met by the end of next year. This comment is more dovish than some of his colleagues.

For example, St Louis Fed President James Bullard expects two hikes in 2022, since he is concerned that high(er) inflation could again become ingrained as part of the U.S. economy.

Bullard believes that while the supply chain issues are abating slightly, they could remain an issue throughout 2022. This could lead to still higher wage demands, which will feed through into a more generalized form of inflation permeating the entire economy.

Charles Evans, the Chief Executive of the Chicago Fed, spoke of his concern that transitory inflation created by supply chain bottlenecks has not faded more quickly. He believes that the FOMC is correct to give itself a degree of flexibility in order to react to changes in trend.

Following on from Friday’s more encouraging employment report which saw the unemployment rate fall to 4.6%, Bullard commented that he believes that the rate could fall below 4% in the first quarter of next year. He also believes that the economy will grow in excess of 4% through 2022.

The dollar index remains in the same range that has dominated recently. It is still unable to mount a serious assault on resistance around the 94.50/60 level.

Yesterday, it fell to a low of 93.99, closing at 94.05

But the inflation split is widening

It emerged yesterday that Portugal has been the biggest user of the ECB’s PEPP funding during the pandemic.

It has also been characterized as a victim of the UK’s bizarre use of a traffic light system to advise its population about whether it is safe to travel there.

The Portuguese economy has been devastated by the effect on its travel and tourism sector. This area makes up close to 20% of GDP, having risen from a little over 10% in 2000.

It is suffering from lower-than-average growth and higher than average inflation,and will need access to emergency funding than other economies.

Spain is still struggling to overcome the effects of the Pandemic and despite a general improvement in growth and output within the Eurozone, Spain is still lagging behind. At the end of Q3, Spanish GDP was still 6.6% lower than it was at the end of 2019. This is far higher than Italy, (1.4%), Germany (1.1) or France (0.1%)

As has been mentioned a few times recently, there is a distinct rift developing within the ranks of the ECB concerning the treatment of inflation that is now above the ECB’s long-term target of 2%. Even this masks the fact that in several Eurozone countries, inflation is double that.

In Germany, the newspapers are lampooning Lagarde as wearing designer brands like Chanel when German savers are seeing their retirement funds being decimated by higher inflation.

ECB Chief Economist Philip Lane supports the Central Bank’s stance on inflation, still considering it to be transitory.

Eurozone Finance ministers meet in Brussels today, and inflation is sure to be close to the top of their agenda. Ahead of that meeting, Lane spoke of his belief that inflation is not a chronic problem and the current level of price increases doesn’t warrant a fear of 70s style inflation returning.

Lane is confident that bottlenecks in supply chains will ease, and energy prices will begin to fall or at least stabilize in 2022.

The euro gained against a weaker dollar yesterday, rising to a high of 1.1594 and closing at 1.8. It is forming a strong level of support around the 1.1550 level and that may be tough to break in the next week or so, although a lot depends on inflation data from both the U.S. and Eurozone that will be released tomorrow.