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James Lovick
October 15, 2021

Fears of Inflation Driving GBP Higher

Sterling Gains on Higher Than Expected Inflation

GBP

The pound saw a good days trading against the Euro yesterday as it continues to test the higher levels in this recent range taking us close to the 18-month high last seen in August. Fears of high UK inflation are currently driving the pound higher. Michael Saunders who sits on the Monetary Policy Committee at the Bank of England has said that he feels markets are correct to price in earlier rate hikes than what had initially been expected. Even the Governor Andrew Bailey has warned of a very damaging period of inflation for UK consumers. The current energy crisis has highlighted that gas prices have more than quadrupled this year. The impact on both households and businesses will be staggering. The markets are now gearing up for a 15 basis points increase by the end of this year.

UK inflation data is released next Wednesday and will help determine at the Bank of England whether the recent spike in prices is as short lived as was initially forecast. The persistent higher prices in recent months are persuading some of the central bank’s policy makers to become more hawkish in their approach. Any evidence that inflation is becoming embedded will likely increase those expectations of a sooner interest rate hike. As David Smith writes in The Sunday Times, “the only way is up for interest rates, even if the bank is not itching to raise them.” The next meeting is in less than three weeks’ time and volatility for the pound is expected in the run up to this event.

The Bank of England has forecast problems ahead for small businesses with a likely rise in collapses. In a report last week, it highlighted that a third of UK small businesses are highly indebted with levels of debt escalating in many cases. As the furlough scheme came to an end in September there is an expectation that insolvencies are likely to rise from here on. This could prove damaging for the economy and for the economic recovery.

Talks between the UK and EU have taken place this week and look set for further intensity surrounding the Northern Ireland protocol. The UK asked this week for significant change to the Northern Ireland protocol whilst the EU put forward their own proposals including some concessions from Brussels. The UK seeks an entirely new protocol although European Commission Vice President Maros Sefcovic has said that he is not ready to renegotiate it. David Frost will meet his counterpart in Brussels for lunch today. The UK’s demand that the European Court of Justice is no longer to have oversight appears to be the latest sticking point.

For now, pigs in blankets will be back in time for Christmas as foreign butchers are to be allowed to work in the UK on temporary visas.

EUR

The European Central Bank is taking a starkly different approach to monetary policy compared to the UK. ECB President Christine Lagarde has recently cited that tightening policy too soon could harm the economic recovery and lose jobs.  Presently the divergence between both the UK and EU central banks is becoming greater. In currency terms it indicates a strengthening of the pound whilst a weakening in the Euro. The ECB’s chief economist said this week. “We need to be much less trigger happy; we need to wait for the data. The medium-term inflation dynamic is too slow, not too fast.” Even the ECB’s President Christine Lagarde has said “The key challenge is to ensure that we do not overreact to transitory supply shocks that have no bearing on the medium term.”

It will be interesting to see if EU policy makers quickly change tact as we have seen happen in both the UK and US.

EU inflation data is released next Wednesday and should be an important event in the calendar. Any changes in policy are likely to have a considerable impact on Euro exchange rates.

European trade balance data are released this morning whilst consumer confidence figures and purchasing managers index data for the manufacturing, contraction and services sectors all released next week could offer clues as to the health of the EU economy and said that it could last longer “than they currently assumed”. The view is that its policies have almost reached the economic goals. Asset purchases are now expected to come to an end in the middle of 2022. The markets are also now pricing in a 50% chance of Fed hike by July of next year. Commitment to taper and eventual interest rate hikes should help support the dollar.

US retail sales data are released this afternoon and may offer some clues as to the overall health of the world’s largest economy.

USD

The performance of the US economy continues to give mixed messages following much weaker US non-farm payroll data last week. US jobs growth stalled for a second month running with only 194,000 jobs being created in September, and considerably lower than the 366,000 recorded in August, which too disappointed market expectations. Although US schools re-opened last month which should have eased childcare problems for many workers, there remains a shortage of labour. These statistics are raising concerns that the US recovery may take longer than expected.

The US non-farm payroll data is important for policy makers now as Fed chair Jerome Powell had previously hinted that a “decent” jobs report would be the benchmark for the Fed to begin tapering its asset purchasing scheme. The question now is whether the data was weak enough to persuade the Fed to delay a taper in November.

US inflation data released this week rose to 5.4%. It pushes inflation to a 13-year high with prices expected to rise further following the recent surge in energy prices. Jerome Powell has blamed supply chain bottlenecks for high inflation and expects it to be a short-term problem. These numbers could suggest otherwise and will certainly put more pressure on the Fed to take some action. The latest Fed minutes from the September meeting certainly hint there could be a tapering of its monthly asset purchases as soon as mid-November. Policymakers cited inflation as a risk for the economy.

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