Daniel Johnson
November 10, 2021

Bank of England hold off on Rate Hike

It has been an interesting period for Sterling, with significant volatility against the majority of major currencies. The market driver has been UK monetary policy. There was high expectation for an interest rate hike from the Bank England (BOE) which failed to materialise.

The market moves on rumour as well as fact and the high likelihood of a rate hike caused Sterling to hit an 18-month high against the Euro, striking 1.19 dead very briefly.

When the rate decision arrived, however, it did not deliver as anticipated and a rate hike was put on hold which saw the Pound lose value, dropping as low as 1.1670. The decision on interest rates is made by the monetary policy committee (MPC), it is made up by nine members who vote on whether there should be any change to interest rates. The vote landed at 7-2 against.

This is not to say that a rate hike is not on the cards, it is likely we will see a rate hike in the not too distant future as a hike in rates is needed to tackle current high levels of inflation, if inflation were to continue to rise without wage growth the UK economy would no doubt start to experience problems.

The next rate decision is due to take place in December, although historically the BOE rarely alter rates during the December decision. The last time this occurred was 13 years ago and it was due to a pretty serious economic event, the Lehman brothers collapse. Interest rates changed 5 times in a very short period of time to combat the fallout.

As the interest rate decision now takes place every six weeks, the next decision following December’s will be in February. This seems the most likely time for a rate hike and could benefit the Pound.

Following the drop to 1.1670 we did see Sterling recover against the Euro moving back into the 1.17s during yesterday’s trading. This could be the opportunity Euro sellers have been waiting for.

Eurozone Inflation makes unhealthy rise

According to the European Central Bank (ECB) current levels of inflation are temporary. ECB chief economist, Philip Lane reiterated the bank’s long standing stance that high price growth was going to be temporary in a recent interview with the Spanish press.

“We believe that next year bottlenecks will ease and energy prices will decline or stabilise,”  Mr Lane told El Pais. “This current period of inflation is very unusual, temporary, and not a sign of a chronic situation.”

Sovereign borrowing costs across the bloc held near multi-week lows after investors scaled back expectations for aggressive interest rate hikes from major central banks in the face of growing inflationary problems.

European Union finance ministers are currently discussing the worrying increase in consumer prices, its impact on wages within the Eurozone and changes they would like made to the bloc’s budget rules to reduce debt and to support future investment.

Year on Year inflation rose to 4.1% in October, up from the previous month’s reading of 3.4%. The ECB are concerned that the continual rise in inflation could cause stronger wage growth creating an inflationary spiral.

“We always expected inflation numbers to pick up this year, but this has been faster than expected and we see levels we have not seen for a long time,” said a senior EU official involved in a recent meeting. “The 4.1% should generate a discussion.”

The rise in October was mainly due by a 23.5% jump in energy prices, which would eventually fall again, though probably not to the levels before the COVID-19 pandemic, the official said.

“We should come back to more benign inflation numbers, but the process will be slower than expected and the risk of second-round effects in wage formation is clearly something that needs to be taken seriously and monitored,” continued the official.

The Eurozone has struggled with low inflation for many years and it seems now the ECB is going to have to combat the exact opposite. This situation will be very difficult to deal with and no doubt there will be changes to monetary policy. If not handled correctly this could be a significant burden for the Euro long term.

Let the Tapering Begin

Federal Reserve Chair Jerome Powell stated we can be patient on raising interest rates after he announced a start to reducing their bond purchases, but he certainly won’t ignore inflation concerns and will be willing to take changes to monetary policy if necessary.

“We think we can be patient. If a response is called for, we will not hesitate,” he said it would scale back by $15 billion a month starting this month.

“We don’t think it is a good time to raise interest rates because we want to see the labor market heal further,” he continued.
After Powell’s remarks, the S&P 500, closed at an all-time highs for a second straight session, something not achieved since January 2018.

The bond buying scheme was taken to the extreme of late in efforts to fight back against the economic fallout from Covid-19. Scaling back on the scheme is good news for the Dollar, but inflation remains a key concern.

Central banks in developed economies around the world are looking closely to the risk of inflation as supply-chain jams spur shortages amid strong demand. The Federal Reserves  inflation measure was 4.4% in the 12 months ending September, this is the highest level in thirty years and more than double the central bank’s target. Consumers’ expectations for prices climbed to 4.2% in the same month, the highest since 2013.

“Inflation is elevated, largely reflecting factors that are expected to be transitory,” A Federal Reserve representative stated.

 “Supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to sizable price increases in some sectors.” 

It seems the Fed are trying to calm concerns surrounding inflation, but as with many other countries battling inflation caused by the pandemic, it will be how the Central Bank reacts to the problem that will dictate the areas currency value.

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