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James Lovick
October 20, 2021

How will the Expected Inflation Data Affect Currencies?

GBP EUR reaches pre-pandemic levels

UK

The governor, Andrew Bailey, has warned that the rising inflation rate will mean that the Bank of England “will have to act” and likely result in UK interest rates rising. Despite the governor making this statement, he has given no concrete indication of when the rates will increase from their current low of 0.1%. The future trajectory is strengthened by the fact that The Bank of England has already stated that inflation is set to exceed 4% as the UK undergoes economic recovery. The governor has also suggested that the rise in inflation will be driven by the surging energy prices. This is evidenced by the recent statistics that show that prices have rose by 3.2% per annum on average. In order to stabilise and reduce inflation rates to the target of 2%, investors are expecting interest rates to increase in Q4 2021 or early in 2022. The UK employment market is deemed to be a seller’s market with around 1.2 million vacancies available in September 2021- a new record high! The UK Prime Minister, Boris Johnson has stated that the response to this should be a pay rise as he resists easing rules for foreign workers. However, the economic problem then becomes that pay does not necessarily have a positive correlation with productivity and will most likely lead to higher prices as employers pass the burden on to consumers. Ultimately, the cyclical impact of inflation leads to a negative wealth affect with the cost of living increasing coupled with increased cost to employers with a rise National Insurance Contributions, some of which will also feed through to increased prices.

Euro

After the Bank of England governor, Andrew Bailey, suggested that the Central Bank will potentially raise interest rates in response to inflationary pressure, as a result we saw Sterling reach a 20-month high (since February 2020) vs the Euro on Monday. Statistically, the Sterling has increased by 5.5% in comparison to the Euro in 2021. The expectation is that the BoE will increase interest rates as an expansionary monetary policy measure to support the British economy amid rising COVID-19 cases, an energy crisis and the shortage of labour due to the rules on foreign workers. The increasing global demand has created similar problems for all economies as they reopen, however economists have pondered if Brexit has exacerbated some of these issues for UK. For example, there is a shortage of 100,000 truck drivers in the UK primarily due to the restriction of post-Brexit migration rules for EU nationals. The shortage of truck drivers has caused disrupted deliveries, ultimately leading to empty stores, increasing port backlogs and vacant gas stations, which triggered a panic buying flurry in September all over the UK. The gas industry is not the only one to see impacts of the economic turmoil, other sectors have also advised of growing labour shortages. This can be exemplified by the Britain’s National Pig Association providing early warning of up to 120,000 pigs faces being culled over the next couple of weeks because of a lack of butchers and abattoir workers. The net impact of the economic circumstances is the reduced availability for goods and services and increased prices in the festive period up to Black Friday and Christmas. 

Dollar

The US dollar hit a one-year high on Monday due to the rising inflation expectation and higher bond yield boosted its economic appeal. This is exemplified by the five-year bond yields rising to their highest levels since February 2020 due to the increased investor confidence that the U.S. Federal Reserve is planning to increase interest rates as early as next year. HSBC analysts have stated that “For some time our central argument has rested on two factors coming together to support the dollar, namely the moderation in global growth and the Fed taking a gradual path towards eventual rate hikes,”. The hike in the dollar index from 0.1% to 94.02, bringing it closer towards last week’s one-year high of 94.563 which was the peak level since September 2020. The US political turmoil continues, Joe Manchin, an U.S. Democratic Senator from West Virginia raised his concerns through social media platforms over the scope of the legislation in response to an editorial from Bernie Sanders, an independent senator from Vermont on President Joe Biden’s multi-trillion-dollar spending package. Biden’s proposed legislation is an ambitious package on policies such as free education, the climate crisis and healthcare provision. The political problem faced by the U.S. is that for bills to pass under a 50-50 Senate, it needs every Democratic senator to vote ‘yes’. In the current situation on the ‘Build Back Better plan’, there are only 48 that have approved the bill. Two Democratic senators remain in opposition, including senator Joe Manchin.

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