Until it Breaks
Until it Breaks
Last Thursday, The Bank of England took markets somewhat by surprise when they belated moved Base Rate up by 50bp, slightly more than anticipated. Sterling’s reaction was telling as it initially rallied before slipping. Despite the wishes and prayers of mortgage holders, I don’t believe this will be the last move, and markets are now expecting another 50bp in August, followed by at least another 50bp before the year-end taking the terminal rate towards 6%. Whether this is the highest that rates go is, of course, dependent on how sticky inflation is, and if it continues to prove stubborn, as some are forecasting, rates could reach 7%. There are two points that need to be made and considered. Firstly, the Bank of England has been very slow in moving interest rates into restrictive territory and has been, in reality, reacting to events not getting ahead of them. Secondly, it is becoming clear that the age of cheap money and interest rates at or around zero is gone. Certainly, yield curves bear testament to the fact that we are now going to see interest rates back at “normal “levels for years to come.
Of course, the Bank of England isn’t alone in raising rates as fears that core inflation is proving to be stickier than many anticipated. Whilst labour markets still remain tight and employment holds up, it is unlikely that any easing of policy will happen. The problem with central banks being data dependent is that so many of the numbers they analyse are no longer valid in a post covid world. Certainly, employment and attitudes to work have changed enormously over the last three years and one wonders whether central banks are indeed making the right calls. The received wisdom is to tighten interest rates until something in the economy breaks, and a recession ensues. The recession then dampens demand, prices fall, and inflation is slowly brought under control. But what if you are not looking at the right indicators? The risk is that the current bout of stagflation that Western economies are suffering from turns into something much worse, and a full-on depression ensues.
Not a joyful start to the week, but when one looks at the money supply, a key indicator of inflationary trends in the 1980s, it is shrinking faster than it has done for decades. In actual fact, it has only shrunk quicker on six previous occasions. Five of these occasions heralded or were in depressions, and one was due to a banking collapse. Another worrying fact is that the last time CPI declined for 11 straight months was in 1921, which saw an extreme recession and deflation. Have the central banks turned from whatever it takes to whatever it breaks as a policy? On Wednesday, they will be able to enlighten us when the big four central banks take to the stage at the ECB Forum on Central Banking in Sintra.
Following what were, let’s be honest, horrible inflation figures in the UK, this week sees the release of the latest data on prices from both the US and Europe. Jay Powell certainly came out fighting last week in his testimony on the hill, but markets still seem to disagree with him and only really expect one, if that, more move upward in Fed funds. This disconnect from the Fed’s dot plot will be partly proven one way or tother after this week’s inflation data. The wonderfully named Core Personal Consumer Expenditure Deflator is published this coming Friday, with many hoping for a fall despite analysts calling it unchanged. Unless there is a marked drop, the markets will continue to expect a further move upwards in US interest rates at the Fed meeting in July. Also, Canada and the Eurozone will release their latest inflation data tomorrow and Friday, respectively, which will be watched more closely than ever. Canada’s data, which includes GDP, will be of particular interest following their recent surprising rate hike. UK GDP is also on the agenda this week for first thing Friday morning, and hopes are up for a good number, especially after Retail Sales printed a stronger performance than anticipated last Friday. According to the ONS, the sales figures were boosted by summer, putting an appearance in, hopefully not a brief one, but they could point to a slightly better GDP than forecast. However, it is plain to see that the economy is still crawling along at the pace of a supine snail, and the UK is increasingly in the grip of stagflation.
Finally, there appears to be no sensible reason to dissect what may or may not be happening in Russia, as whatever we speculate is sure to be ill-informed. As Blonde Money’s Helen Thomas wrote in her excellent note over the weekend, ” Deals are being done in the background but this is the murky world of gangland organised crime, not four-dimensional Kissenger-esque diplomatic chess” One thing is certain, though, the eternal truth that we should all be careful of what we wish for holds good.
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