Beyond Currency

Silvana Tenreyro is the most dovish independent member of the Bank of England’s Monetary Policy Committee. She has voted for interest rates to remain unchanged at the last two meetings of the committee.

Yesterday, she spoke of her view that the Central Bank may need to cut interest rates earlier than has been previously forecast in order to avoid what she called a significant inflation overshoot.

She believes that as the full effect of previous rate hikes are fully felt, they will drag down the economy, raising the spectre of a recession.

Last month, the MPC voted to raise rates for the 11th consecutive meeting, raising the base rate to 4.25%.

It is widely felt that the Bank will raise interest rates by a quarter of a percent at its next meeting on May11th, and then announce a pause in hikes.

Beyond Currency Market Commentary:

Aims to provide deep insights into the political and economic events worldwide that can cause currencies to change and how this can affect your FX Exposure.

The release of GDP data recently, which showed that the economy grew by 0.1% in the final quarter of 2022 is expected to have a positive effect on the growth figures for this year.

According to a note to investors published by the London office of Deutsche Bank yesterday, the data released by the Office for National Statistics last week confirmed that the final figure for GDP in 2022 was 4.1% up from 4% previously.

The positive carry-over of the data has, according to the German bank’s economic models, improves the chances that the UK economy won’t see a recession this year, but that is where the good news ends as the economy will almost certainly stagnate with whole year GDP of 0%.

Despite no upgrades to its quarterly projections, Deutsche sees an improvement of 0.2% overall on its overall data for the year.

With the economy on a tightrope this year, even the slightest adjustment to forecasts will create an overall change in the data. The Bank of England appears to still be considering its next move. Arch-hawk Catherine Mann tempered her tendencies last month, and voted for a twenty-five basis point rise in base rates, in line with most of her colleagues.

Beyond Currency Market Commentary:

Aims to provide deep insights into the political and economic events worldwide that can cause currencies to change and how this can affect your FX Exposure.

The Bank of England is expected to bring to an end its series of rate hikes in May after it agrees on one final hike. The view of the market is that rates are either at a restrictive level now, or will be following another hike and there is a danger, given the perceived fragility of the economy, that there is a danger that the Central Bank may tip the economy into recession.

This is especially true given that, in its own words, the Bank expects the economy to be flat this year. Any further tightening of monetary policy runs the risk of being the final straw.

Former Chief Economist at the Bank, Andrew Haldane, spoke last week of his fear that any further hikes would set aside the progress that has been made in the balancing act between growth and inflation.

The fifteen-month-long sequence of rate hikes hasn’t completely fed through into the economy yet, and the Monetary Policy Committee would do well to pause to allow the total effect to be seen. If after a pause inflation remains uncomfortably high, there is no reason that further tightening could take place if it was deemed necessary.

With the base rate of interest now at 4.25, its highest since 2008 when rates were cut to provide a significant amount of support to the market following the financial crisis, Haldane believes that the MPC has an opportunity to view the effect of a natural fall in inflation without placing the economy in further jeopardy.

Beyond Currency Market Commentary:

Aims to provide deep insights into the political and economic events worldwide that can cause currencies to change and how this can affect your FX Exposure.

The Bank of England will face a difficult decision at its next monetary policy committee meeting. Although headline inflation is moving in the right direction, the core remains uncomfortably high and is showing less inclination to be driven by tighter monetary policy.

Catherine Mann, commented in a speech yesterday that the Central Bank will need to find other ways to affect underlying inflation and that will make it difficult to decide monetary policy as the year progresses.

With energy prices on a downward slope, headline inflation is continuing to fall, and the between headline and core prices is narrowing. The prices of services and goods remain in an uptrend, which could be an issue going forward.

The mild winter in Europe has seen demand for energy decrease. Although the high cost of energy fed through into almost every area of consumer spending, that pressure is now decreasing.

The 2% target for inflation is set in relation to the headline figure, and this will be extremely difficult to meet given a persistent and unmoving core.

Beyond Currency Market Commentary:

Aims to provide deep insights into the political and economic events worldwide that can cause currencies to change and how this can affect your FX Exposure.

The popular view in the markets currently is that the Bank of England will call a halt to its long-running programme of rate hikes in May after raising short term rates once more.

There is a degree of optimism about the economy which is leading commentators to believe that the bank won’t need to cut interest rates to stimulate the economy unless there is any further fallout from the recent collapse of two U.S. banks which has precipitated a liquidity crisis.

The Central Bank is trying to encourage companies to invest in their businesses. The level of purchases of new machinery and plant by businesses of all sizes has not really recovered from the near collapse that was seen during the Pandemic.

No matter how much confidence grows that the Government is now on the right track, with inflation falling which will lead to an increase in real wages, there is still the political uncertainty generated by opinion polls which still put the Labour Party well ahead and therefore barring some unforeseen disaster likely to be elected to power after thirteen years in opposition early 2025.

Following the somewhat bizarre events of last summer that followed the election of Liz Truss to succeed Boris Johnson as Conservative Party leader and Prime Minister, the country is gradually returning to its more traditional beliefs. The first is that under a Labour Government, public sector borrowing rises considerably as investment increases in services and social care.

Beyond Currency Market Commentary:

Aims to provide deep insights into the political and economic events worldwide that can cause currencies to change and how this can affect your FX Exposure.

The Prime Minister spoke yesterday of his confidence that the economy will see a return to a level of growth that is at, or above, trend next year. Rishi Sunak acknowledged that Brexit and the shocks created by the Coronavirus Pandemic had set the country back.

He went on to say that while all developed economies have faced their own unique challenges, the global increase in inflation has been a common theme. He praised the Bank of England for the manner in which it has tightened monetary policy over a period of eighteen months. Raining interest rates at eleven consecutive meetings.

The challenges that Andrew Bailey and his colleagues have faced have underlined the importance of having an independent Central Bank.

Bailey himself and his colleague, Deputy Governor, David Ramsden, testified before the Treasury Select committee yesterday. They were providing MPs with their views on the collapse of the Silicon Valley bank in the United States and any possible effect there may be to the financial markets in the UK and Europe.

Bailey said that the collapse of the band, primarily set up to cater to the financial needs of tech startups, was the fastest seen since the Barings Bank crisis in February 1995. He went on to say that it was unlikely that the issues that led to the sale of Credit Suisse to Union Bank of Switzerland were company specific.

Beyond Currency Market Commentary:

Aims to provide deep insights into the political and economic events worldwide that can cause currencies to change and how this can affect your FX Exposure.

At last week’s meeting of the Bank of England’s Monetary Policy Committee, there was a significant shift in the Bank’s view of inflation. While they still hiked interest rates, for the eleventh consecutive time, to 4.25%, the highest they have been in fourteen years, there was a lowering of expectations for inflation that will be reflected in its Quarterly Economic review that will be published later today.

While in the recent past the bank has hoped that inflation will be falling by Autumn, members of the MPC now believe that it will have fallen to close to its target of 2% by the end of the third quarter.

Interest rates are expected to peak at 4.50% with a hike at the next meeting due to be held on May 11th expected to be the last in the current cycle.

It remains to be seen whether Andrew Bailey will announce this as a policy change, or whether he will remain cautious by continuing to say that the committee is driven by the data.

Committee members have for several meetings expressed their individual reasons for why they voted as they have. The most definitive views have been provided by the independent members. There was a danger that Catherine Mann, Silvana Tenreyro, and Swati Dhingra were going to use the MPC as an exercise in economic theory, since the fourth independent member, Jonathan Haskell tends to be seen as in step with the Bank of England’s in-house views.

Beyond Currency Market Commentary:

Aims to provide deep insights into the political and economic events worldwide that can cause currencies to change and how this can affect your FX Exposure.

Analysts at the Office for Budget Responsibility have predicted that the Bank of England will most likely hike short-term interest rates once or twice more before calling a halt to their programme of tightening monetary policy, which has lasted for fifteen months and seen rates climb to their highest level for fourteen years.

Rates are therefore unlikely to reach the 5% level which was predicted by market commentators three months ago. With the base rate of interest currently at 4.25%, it is now likely that the Bank will stop at either 4.25% or 4.75%.

It is now considered unlikely that, unless the current turmoil in the financial markets continues or sees further banks face severe liquidity problems, that rates will remain unchanged for the rest of the year,

Catherine Mann, far and away the most hawkish of the four independent members of the Monetary Policy Committee, spoke over the weekend of her view that inflation will recede over the summer and that is why she voted for a smaller hike than she has done over the past few meetings.

She feels that the effect of the recent rate hike is now being seen in the inflation data, and that provided some motivation for her to vote for the twenty-five point hike that was eventually agreed.

Beyond Currency Market Commentary:

Aims to provide deep insights into the political and economic events worldwide that can cause currencies to change and how this can affect your FX Exposure.

One of the most telling statistics from the housing market and the effect of fifteen months of rate hikes has been the fall in stamp duty receipts. There has been a 27% fall compared with the same month a year ago.

The fall from £1.3 billion in February 2022 to £900 million last month is a product of the severe squeeze that has been placed on household budgets by rising inflation. With real wages continuing to fall there is little prospect of any revival in activity before the end of the year.

Following the mayhem caused by the mini budget during Liz Truss’ premiership when home loan rates blew out causing a number of lenders to withdraw mortgage products, the market has calmed down somewhat although it has not yet returned to pre-Truss levels yet.

With short term interest rates already at a fourteen year high, borrowers are anxiously awaiting the result of tomorrow’s MPC meeting. It is likely that another twenty-five basis points will be added to the base rate bringing it to 4.25%.

Given Andrew Bailey’s penchant for being almost apologetic for the continuation of the tightening of monetary policy, it is hard to predict when the Bank will call a halt.

Beyond Currency Market Commentary:

Aims to provide deep insights into the political and economic events worldwide that can cause currencies to change and how this can affect your FX Exposure.

The current situation in the banking sector is such that the Bank of England will need to consider its options very carefully when it meets tomorrow to decide about whether or not to raise short term interest rates.

David Blanchflower, a member of the Monetary Policy Committee during the 2008 financial crisis, believes that the Bank should consider radical action at this week's meeting in order to get ahead of the issue.

While the markets see either a further hike taking the base rate to 4.25%, Blanchflower believes that a cut of around 1.5% would send a positive signal that the Central Bank is not prepared to passively wait for the situation to escalate before taking action.

He also believes that the sale of bonds that were purchased during the coronavirus pandemic should also be reversed to boost money supply. This so-called quantitative tightening would increase the size of the Bank’s balance sheet again, but during a time of crisis it needs to be as proactive as possible to boost the markets' confidence.

He labelled the the current action in which the Bank plans to reduce its holdings of bonds by eighty billion pounds over a twelve-month period as lacking imagination. The Bank has few tools with which to affect money supply, and it is not making use of this one.

Beyond Currency Market Commentary:

Aims to provide deep insights into the political and economic events worldwide that can cause currencies to change and how this can affect your FX Exposure.