Beyond Currency

The UK economy as expected avoided a contraction in the first quarter despite an unexpectedly large fall in growth in March. The economy shrunk by 0.3% in March which highlighted its fragility.

With the Bank of England under pressure to continue to hike short-term interest rates, it has little “wiggle room” to play with which could see monetary policy take the economy into a recession.

Although there was a collective “sigh of relief” from the market, the Government, and the Central Bank when the IMF concluded that the country is unlikely to suffer a recession this year, there is a growing concern that the economy may struggle to avoid a contraction in 2025.

Rishi Sunak and his Cabinet are clearly relying on an improving economic performance to provide them with a slim chance of remaining in Government following the General Election which must take place before January 2025, but is slated to happen in the Autumn of next year.

The BBC interviewed Larry Summers, the eminent economist, and Treasury Secretary during the Presidency of Bill Clinton last week and painted a particularly dark picture of the country’s prospects. He believes that it is “highly unlikely” that there will be no recession during the life of this Parliament, also commenting that Brexit is the single factor that marks the UK from its G7 partners when it comes to inflation, which will in time be seen as a “historic error”.

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 UK economy suffered a pair of blows yesterday after a month of generally good news since the IMF announced its “volte-face” over the nation’s performance over the rest of 2023.

The Nationwide survey of house prices was published, and it showed that across the entire country, prices fell by 3.4% in May, its largest fall in close to fourteen years.

Then Larry Summers, the influential economist and former U.S. Treasury Secretary commented in an interview that it would be a major surprise if the UK didn’t suffer a recession in the next two years and that even this year, it is not out of the question that the economy could slip into a mild recession this year.

The Nationwide Building Society in a report that accompanied the data warned that further interest rate rises could see the market fall by even more.

This may be good news for first-time buyers who have seen house prices continue to rise in the past few years, even during the Pandemic, although then Chancellor, Rishi Sunak provided significant support in the shape of cuts to stamp duty.

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 MPC’s most hawkish member Catherine Mann made a speech yesterday in which she again raised concerns about the potential for inflation to become ingrained in the UK economy.

Mann believes that the UK has a more significant issue with core inflation than most of its G7 partners. She said that it was a structural issue where companies, both public and private, are so desperate to protect their profit margins that they pass wage increases directly to their customers by increasing the price of their products.

One classic example of this is the railways, which are supposedly privatized but the Government is currently engaged in a tough series of negotiations with several sectors of the industry. The UK has the highest train fares in Europe or the U.S., while its service is mediocre at best.

The cost of a ticket bears little relationship to the distance travelled, the frequency of the service, or the condition of the rolling stock or infrastructure.

Inflation in the UK reached a high of 11.2% in October last year and in April was still at 8.7% making the UK the joint highest, with Italy, in the developed world.

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 UK economy is facing some major issues in the long term as the Government tries to put in place a strategy that will leverage Brexit while the Bank of England tries to extinguish the threat of inflation.

While it is now generally agreed that the country will now face a recession this year, thoughts are turning to the long-term prospects which may include a leap into the unknown as the people decide it is time for a change of Government.

The last time this happened was in the nineties when Conservative Party “shot itself in the foot” and ushered in the Blair/Brown years.

It may be that the country needs a fresh approach, but the current Labour leadership is hard to understand. Yes, they ” make noises” about the need for change and how they will cut debt, while at the same time investing in the future of the country.

Without being sceptical, whenever Shadow Ministers are asked the how of their policies, they do little more than make hopeful noises, critical of the current situation but fail to add any “meat to the bones”.

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.

High inflation is going to remain a global economic factor for at least the rest of 2023 and possibly well into next year as Central Banks review plans to begin to pause the cycle of rate hikes.

Inflation has fallen but not as fast as global bodies like the World Bank and the IMF had expected, and it is likely that they will have to again revise their predictions for the major, as well as developing economies.

Although the ECB remains committed to defeating inflation by a seemingly continuous cycle of rate hikes, both the Federal Reserve and the Bank of England had been considering a pause perhaps starting at their June meetings.

Although headline inflation has fallen back into single figures in the United Kingdom according to the data for April, it has not fallen as quickly as had been expected, due mainly to continuing price rises in basic foodstuffs.

Core inflation has become stuck at between 6% and 7% having risen from 6.2% to 6.8% last month.

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.

Andrew Bailey the Governor of the Bank of England has had a difficult time since the Bank began to raise interest, after several years of benign inflation, combat rising prices that, with the benefit of hindsight, bound to rise as the effect of the massive fiscal support throughout the Pandemic, the Russian invasion of Ukraine and rapidly increasing demand had a significant effect on the economy.

Bailey was not alone in being caught off guard, Jerome Powell and Christine Lagarde have also suffered criticism for not taking the threat of rising inflation seriously.

However, Bailey alone has been almost apologetic every time he has announced yet another rate hike, while his G7 colleagues, the Federal Reserve in particular, have been far more dynamic and committed to tighter monetary policy.

The Bank of England started to tighten monetary policy first among G7 nations, using a series of twenty-five basis point hikes, possibly underestimating for a second time the seriousness of the threat that rapidly rising inflation could be to the economy.

While the country’s G7 partners were undertaking fifty and even seventy-five basis point hikes, the Bank of England continued to hike rates by twenty-five points for fear of tipping the economy into a recession.

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 latest data for inflation was published yesterday, and it showed that although headline inflation fell back into single figures, the fall was less than expected at an annual rate of 8.7% versus 10.1% previously.

The market was expecting the fall to be even greater at 8.1%. This means the likelihood of the Bank of England hiking interest rates again at its next rate-setting meeting is more likely than previously expected.

Core inflation, the rate with more volatile items like energy and foodstuffs stripped away, rose in April to 6.8%, up from 6.2%.

This was the outcome that Andrew Bailey, the Bank’s Governor had warned about last, when the spike about a wage/price spiral, where headline inflation begins to fall, but the core is propped up by the lag in wage settlements that were negotiated while inflation was far higher and only now are coming into force, beginning.

The data chimed with the IMF report published the previous day which predicted that the UK would avoid a recession this year, but that inflation would remain stubbornly high.

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.

Bank of England Governor, Andrew Bailey, attended a conference in the U.S. in which the amount of advance guidance that is given to the markets of Central Bank monetary policy intentions was discussed.

Over several years, and even up until very recently. There was little market interest in what the Bank was doing since inflation was low for several years, so interest rates were allowed to fall, then over the past eighteen months, as prices of energy and foodstuffs have skyrocketed, tightening of policy has been both necessary and obvious.

At the margin of policy changes, as the Bank is either beginning or ending policy changes, is when the advance guidance to the market needs to be considered.

During the cycle of rate increases, only the increments are of interest to analysts and investors, since as inflation continues to rise, a hike becomes a foregone conclusion.

The G7 nations which met in Japan last week, are all arriving at an inflection point in policy changes where the markets are expecting them to call a halt to further increases.

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 must guard against “painting itself into a corner” by providing guidance to the markets about its intentions regarding monetary policy.

That was the conclusion of a conference hosted by the Federal Reserve of Atlanta earlier this week. By providing guidance to the markets in advance the Bank faces the prospect of either being accused of misleading traders and analysts should subsequent data releases mean it has to change its mind or pre-empting the votes of committee members who are entitled to have sufficient time to consider all options before casting their vote.

It becomes far harder to pivot on interest rates when the market has already been appraised of the Bank’s intentions.

Over the past year or so, the intentions of the Monetary Policy Committee were fairly clear, so advance guidance was acceptable, but as rates reach neutral territory or become restrictive on demand, the actions of the MPC become a little less clear.

Maybe having signalled a pause in rate hikes, data on, say, inflation, output or employment may unexpectedly spike, which would leave the Bank open to criticism were it to then hike rates again.

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.

Andrew Bailey spoke yesterday of his concerns that inflation is becoming embedded in the economy since the core is not falling as expected following eighteen months of rate increases.

While the markets continue to speculate about when the Bank will pause the cycle of hikes, Bailey confirmed that it will continue to hike rates until inflation falls to its two per cent target.

Bailey talked of his concern over two specific issues; the continued rise of food price inflation, which remains close to twenty per cent, and the tightness of the labour market, although the latest employment report showed that that pressure eased very slightly last month.

He assured his audience of Chambers of Conference members that the Bank will continue to hike rates until the medium-term outlook is in line with the Bank’s remit.

There were signs in the latest employment report that despite unemployment remaining at historic lows, it is slowly beginning to rise. In the first three months of the year, the unemployment rate surprisingly ticked up to 3.9%, despite evidence that more workers are returning following extended absences due to long covid.

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.