Inflation driving central bank policy

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UK rates expected to rise further as inflationary forecast remains high

It is tough to find any good news for the UK economy as we are facing what Governor Bailey has called a historic shock to incomes.

The UK’s direct exposure to Russian energy is minimal, but the rise in oil and gas prices has set back the recovery, hitting growth to the point that suggestions of recession are on the cards.?Inflation forecasts average around 8%?for the rest of the year, despite the Bank of England looking likely to hike rates again at its next three meetings. That would bring the rate to 1.50%.?

Despite that interest rate outlook, Sterling is failing to make substantial gains. Yesterday the market was pretty volatile as risk appetite improved with rumours of a breakthrough in peace talks. We touched 1.3160 against the dollar, but fell back to close around 1.31 and we open just under 1.18 against the Euro.?

Wage inflation adding to the Fed challenge

The Fed thinks that one of the key drivers of inflation will become the workforce. Where workers find themselves in high demand and the number of vacancies has hovered around 11.4 record level from December, they are able to easily switch jobs for higher wages.?To illustrate the dilemma, last month Non-farm payrolls confirmed 678k new jobs were created, but job openings only fell by 17k but before the pandemic there were about 1.8 job openings for every unemployed worker.?

In the market, the dollar index was hit hard by rumours of positive news from the peace talks, falling to a low of 98.?

ECB policy to remain reactive to data

In contrast to the bullish chat from Christine Lagarde, Governor Philip Lane yesterday injected a sense of realism into the ongoing debate, raising concerns about darkening sentiment across the region as the conflict in Ukraine continues to affect sentiment.

Significant falls in consumer and corporate sentiment will drive the economy lower as inflation continues to rise. He stopped short of mentioning stagflation but he did say that the Eurozone may have to get used to higher inflation.

Despite that, Lane stands by the ECB’s latest forecast, which sees growth at 3.7% and inflation at 5.1% this year, but any rate hike, which would be the ECB’s first in a decade, will be determined by the data.?For now, the Central bank will remain reactive.

Yesterday, the euro rallied strongly on hopes of a breakthrough in peace talks between Russia and Ukraine. EUR/USD opens higher this morning around 1.1115.?