High Inflation and Recession Risk - the Bank of England's Dilemma

Central Bank

Summary:

The Bank of England is trying to curb an inflation rate that is running higher in Britain than in the United States and the euro zone, without pushing the economy into a recession after having already increased borrowing costs 12 times since late 2021.

The BoE is expected to raise rates again, to 4.75% from 4.5%, on June 22 after inflation slowed by less than it hoped in April. Investors see a roughly 60% chance that Bank Rate will climb to 5.5% later this year.

Nonetheless, two of the Monetary Policy Committee's nine members say the delayed impact on the economy of the BoE's rate hikes to date mean there is no need to tighten policy any further.

Below is a summary of the factors the BoE is weighing up as it approaches its next meeting.

Inflation

British consumer price inflation (CPI) fell to 8.7% in annual terms in April, down from 10.1% in March but higher than the BoE's forecast of 8.4%. It was the joint highest among Group of Seven advanced economies alongside Italy's.

More worrying for the BoE, two measures of underlying price growth - core inflation, which excludes energy, food and tobacco prices, and price increases in the services sector - both hit their highest rates since 1992.

However, analysts polled by Reuters last month forecast that headline CPI will slow to 3.7% in the fourth quarter of this year and to just above the BoE's target of 2% in a year's time as last year's surge in energy prices drops out of the figures. The analysts mostly expected Bank Rate to peak at 5.0%.

Inflation Expectations

The BoE takes comfort from signs that inflation expectations are falling after rising in recent months.

Public expectations for inflation over five to 10 years - which are watched closely by the central bank - eased in May to their lowest in nearly two years at 3.5%, according to a survey by U.S. bank Citi and polling firm YouGov.

Companies surveyed by the BoE in May intended to raise prices by 5.1% over the coming year, down from 5.9% in April's survey, the lowest since Russia's invasion of Ukraine.

Wage Settlements

The same BoE survey showed businesses planned to raise wages by 5.2% over the coming year, down from expectations of 5.4% in April and the lowest since July 2022.

But data from human resources firm XpertHR showed pay settlements by employers held at 6% in the three months to April, matching recent record increases.

Inflation Heat in The Labour Market

The BoE is worried about long-term inflation heat from the labour market where a shortage of workers, caused by a rise in the number of long-term sick after the COVID-19 pandemic, has been compounded by new Brexit rules on European Union workers.

There have been some signs of an easing of that pressure recently. More people sought to get back into work in the first three months of the year, pushing down Britain's inactivity rate and easing the need for employers to raise pay to attract workers.

The Rate Hikes Already in The Pipeline

The BoE knows much of the impact of its 12 rate hikes to date has yet to be felt because most mortgages in Britain are fixed-rate deals which protect home-owners from swings in borrowing costs but will come up for renewal at higher rates.

The BoE said in May that 1.3 million fixed-rate mortgages were due to mature by the end of 2023 with more up for renewal in 2024 and beyond, meaning much of the hit to household budgets has yet to be felt.

Recession Risk Remains

Britain's economy has so far defied recession forecasts made only a few months ago, but it remains fragile and the recent jump in expectations of higher borrowing costs may yet tip it into a contraction this year.

British gross domestic product has recovered from the COVID pandemic more slowly than all the other G7 economies bar Germany, according to data for the first three months of 2023.

Source: Yahoo

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Warren Takunda

Traders' Opinions

RIYADH, Saudi Arabia - In a significant boost to Saudi Arabia's ambitious plan to diversify its oil-dependent economy, the futuristic city of Neom has secured a staggering $5.6 billion investment from a consortium of local investors. Neom, an unprecedented project spearheaded by Crown Prince Mohammed bin Salman, aims to transform the Red Sea coast into a cutting-edge hub of innovation and sustainability.

The multimillion-dollar deal, announced today, marks a significant milestone for Neom, which is set to become the centerpiece of Saudi Arabia's vision for a post-oil era. This substantial investment will facilitate the development of temporary housing and state-of-the-art facilities capable of accommodating a staggering 95,000 individuals.

Neom, derived from the Greek word "neos" meaning "new" and the Arabic word "mustaqbal" meaning "future," embodies Saudi Arabia's ambitious aspirations to create an entirely new urban landscape that embraces technological advancements and renewable energy sources. With an estimated cost exceeding $500 billion, Neom is envisioned as a sprawling metropolis powered by 100% renewable energy.

The latest injection of funds into the project showcases the commitment of local investors to Saudi Arabia's transformative vision. The consortium behind this landmark investment is comprised of influential business figures who recognize the vast potential of Neom as a catalyst for economic growth and diversification.

Commenting on the deal, Crown Prince Mohammed bin Salman expressed his gratitude and highlighted the strategic importance of Neom in driving forward Saudi Arabia's Vision 2030 agenda. He emphasized the significance of public-private partnerships in advancing the development of Neom and affirmed that the project remains a priority for the government.

Neom is expected to create numerous job opportunities, attract foreign investment, and stimulate sectors beyond oil, such as technology, tourism, and entertainment. The city's innovative design, complemented by its strategic location on the Red Sea coast, positions it as a prime destination for global investors seeking a foothold in the Middle East.

As Saudi Arabia moves away from its historical reliance on oil revenues, the success of Neom holds great promise for the country's economic transformation. The investment injection of $5.6 billion underscores the confidence of local investors in the project's long-term viability and its potential to reshape the region's economic landscape.

With the support of key stakeholders and a commitment to sustainable development, Neom continues to make substantial strides towards becoming a pioneering city of the future. As construction progresses and further investments pour in, the eyes of the world remain fixed on this ambitious endeavor that seeks to redefine urban living and propel Saudi Arabia into a new era of prosperity and innovation.

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Cohen

Russia-Ukraine Conflict

A huge Soviet-era dam on the Dnipro River that separates Russian and Ukrainian forces in southern Ukraine was breached on Tuesday, unleashing floodwaters across the war zone.

Ukraine said Russia had destroyed it, while Russia said Ukraine sabotaged it to cut off water supplies to Crimea and distract attention from a "faltering" counter-offensive.

What is the dam, what happened - and what do we not know?

The Kakhovka Dam

The dam, part of the Kakhovka hydroelectric power plant, is 30 metres (98 feet) tall and 3.2 km (2 miles) long. Construction was started under Soviet leader Josef Stalin and finished under Nikita Khrushchev.

The dam bridged the Dnipro River, which forms the front line between Russian and Ukrainian forces in the south of Ukraine.

Creation of the 2,155 sq km (832 sq mile) Kakhovka reservoir in Soviet times forced around 37,000 people to be moved from their homes.

The reservoir holds 18 cubic kilometres (4.3 cubic miles) of water - a volume roughly equal to the Great Salt Lake in the U.S. state of Utah.

The reservoir also supplies water to the Crimean Peninsula, which Russia annexed in 2014, and to the Zaporizhzhia nuclear plant, which is also under Russian control.

What happened?

Ukraine, which commented first, said Russia was responsible:

Ukrainian President Volodymyr Zelenskiy accused Russian forces of blowing up the Kakhovka Hydroelectric Power Station from inside the facility, and said Russia must be held to account for a "terrorist attack".

"At 02:50, Russian terrorists carried out an internal detonation of the structures of the Kakhovskaya HPP. About 80 settlements are in the zone of flooding," Zelenskiy said after an emergency meeting of senior officials.

A Ukrainian military spokesperson said Russia's aim was to prevent Ukrainian troops crossing the Dnipro River to attack Russian occupying forces.

Russia said Ukraine sabotaged the dam to cut off water supplies to Crimea and to distract attention from its faltering counteroffensive.

"We can state unequivocally that we are talking about deliberate sabotage by the Ukrainian side," Kremlin Spokesman Peskov told reporters.

Earlier some Russian-installed officials said no attack had taken place. Vladimir Rogov, a Russian installed official in Zaporizhzhia, said the dam collapsed due to earlier damage and the pressure of the water. Russia's state news agency TASS carried a report to the same effect.

What is the human impact?

With water levels surging higher, many thousands of people are likely to be affected. Evacuations of civilians began on both sides of the front line.

Maxar said that satellite images of more than 2,500 square km (965 square miles) between Nova Kakhovka and the Dniprovska Gulf southwest of Kherson city on the Black Sea, showed numerous towns and villages flooded.

Ukrainian officials estimated about 42,000 people were at risk from the flooding, which is expected to peak on Wednesday, including some 25,000 in Russia-held parts. About 80 communities were threatened by flooding.

Crimea

The destruction of the dam risks lowering the water level of the Soviet-era North Crimean Canal, which has traditionally supplied Crimea with 85% of its water needs.

Most of that water is used for agriculture, some for the Black Sea peninsula's industries, and around one fifth for drinking water and other public needs.

Nuclear Plant

The Zaporizhzhia Nuclear Power Plant, Europe's largest, gets its cooling water from the reservoir. It is located on the southern side, now under Russian control.

"Our current assessment is that there is no immediate risk to the safety of the plant," International Atomic Energy Agency chief Rafael Grossi said.

He said it was essential that a cooling pond be left intact as it supplied enough water for the cooling of the shut-down reactors.

"Nothing must be done to potentially undermine its integrity," Grossi said.

Source: Colorado Springs Gazette

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Thomas

Economic

Japan is committed to mobilise all policy options available while putting the economy before fiscal reform, according to a draft of the government's mid-year policy framework reviewed by Reuters on Wednesday, signalling its will to keep the fiscal spigot wide open before looming elections.

The draft framework, which will be presented at Prime Minister Fumio Kishida's top economic advisory panel, provides the basis for medium- to long-term macroeconomic management and will be approved by Kishida's cabinet later this month, along with a separate action plan on his "new capitalism" agenda.

Kishida, who is seen as a fiscal hawk, also hopes to strike a delicate balance between fiscal stimulus and the unwinding of it, with the framework calling for normalisation from crisis-mode fiscal largesse.

Still, the framework dropped a specific timeframe on the budget-balancing target for a second year, reflecting a compromise Kishida needed to strike with reflationary forces within his own Liberal Democratic Party (LDP).

"We have not abandoned the flag of fiscal reform," the framework said, in a tacit reference to Kishida's aim of bringing a primary budget surplus, excluding new bond sales and debt servicing costs, by the fiscal year ending in March 2026.

The target was originally set to be met in the early 2010s but has pushed back four times.

Since he took office in October 2021, Kishida has pledged to achieve a virtuous cycle of growth and redistribution under his "new capitalism", while suggesting that previous administrations' stimulus policies created social division and inequality.

To accelerate the "new capitalism" drive, the new framework calls for a structural increase in wages and the expansion of financial assets, including a decision by the end of 2024 to boost contributions to the defined contribution pension system and the overhaul of asset management firms.

"We will realise sustainable growth by mobilising budget, taxation and regulatory reforms, aiming to exit deflation and sharp declines in childbirth," it said, pointing to downside risks to the global economy because of a prolonged war in Ukraine, the global trend of monetary tightening and elevated inflation.

Source: Reuters

To stay updated on all economic events of today, please check out our Economic calendar

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Warren Takunda

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Economic

Wheat futures in the United States experienced a notable surge, reaching $6.4 per bushel, signaling a recovery from the over-two-year low of $5.9 observed on May 30th. This upward trajectory is largely attributed to the devastating breach of a dam in Ukraine, which is expected to have a significant impact on the country's agricultural sector. The explosion at the Kakhovska hydroelectric dam has severed the crucial water supply that sustains agriculture in the southern region of Ukraine.

Wheat Surges Following Dam Breach in Ukraine, Raising Geopolitical Concerns and Threatening Grain Exports_1

The destruction of agricultural infrastructure, coupled with the resultant water shortage, has raised concerns over the geopolitical implications of the incident. The situation further intensifies anxieties regarding the extension of Russia's seaborne grain export deal, which heavily relies on Ukrainian ports. With the disruption caused by the dam breach, the possibility of an extension appears grim, adding an additional layer of uncertainty to the global grain trade.

Despite these concerns, the surge in wheat prices was tempered by robust output in other regions. Russia, for instance, has witnessed a bumper harvest, leading to an upward revision of foreign sales forecasts to nearly 50 million tonnes. Moscow's recent decision to increase grain export duties has not deterred sellers in the world's top exporter. In fact, they have responded by lowering prices, aiming to manage the current record-high harvest and prevent inventories from reaching unsustainable levels.

While the impact of the dam breach in Ukraine is expected to be significant, the strength of global wheat production in other key regions has mitigated the extent of the price increase. This, however, does not downplay the potential long-term consequences on the Ukrainian agricultural sector and the geopolitical dynamics surrounding grain exports.

Market participants will closely monitor the aftermath of the dam breach and its implications for both domestic and international wheat markets. Any disruption in grain supply from Ukraine could result in a ripple effect across the global market, potentially triggering heightened volatility and impacting food security in certain regions.

As the situation unfolds, market analysts will pay attention to the response from both Ukraine and Russia, as well as the subsequent actions of major players in the wheat market. The resilience of the global wheat supply chain will be put to the test, with potential repercussions for consumers, traders, and investors alike.

In summary, the breach of the Kakhovska hydroelectric dam in Ukraine has sent shockwaves through the wheat market, propelling prices upward as concerns mount over the disruption of agriculture and the implications for grain exports. The repercussions of this event, combined with the response from key market players, will significantly shape the trajectory of the wheat market in the coming months.

To stay updated on all economic events of today, please check out our Economic calendar

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Alex

Economic

Australia's economy grew at the weakest pace in 1-1/2 years last quarter as high prices and rising interest rates sapped consumer spending, while emerging signs pointed to further softness ahead amid elevated borrowing costs and a slowdown in global growth.

Data from the Australian Bureau of Statistics on Wednesday showed real gross domestic product (GDP) rose 0.2% in the first quarter, easing from 0.5% in the previous quarter and under forecasts of 0.3%.

Annual growth came in at 2.3%, also missing forecasts for 2.4% expansion.

The report contained initial signs that domestic price pressures are easing and evidence that households are saving less to meet high costs of livings and rising mortgage rates.

Domestic price growth slowed to 1.1%, after a 1.4% rise in the December quarter, and household savings as a share of income shrank to 3.7%, the lowest level since 2008, with consumers cutting back on discretionary spending such as household equipment and vehicles.

Household consumption rose only a meagre 0.2% in the March quarter, contributing 0.1% percentage points to GDP, mostly from spending on essential goods and services.

Price pressures have prompted the Reserve Bank of Australia (RBA) to raise its cash rate by 400 basis points since last May, taking it to an 11-year high of 4.1% and flagging more tightening may still be required.

Markets have priced in a 60% chance of another hike in July.

Compensation of employees (COE), the broadest measure of economy-wide labour costs, increased 2.4% in the first quarter from the December quarter when it rose 2.0%, a result that would worry policymakers.

RBA Governor Philip Lowe has highlighted that fast increasing unit labour costs are a risk to the central bank's inflation outlook, if productivity failed to pick up from the current flat levels.

Source: Reuters

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Thomas

Energy

The US$2 billion market for carbon offsets is heading for a massive reset, as a growing number of sovereign governments announce their intention to tax, regulate or restrict trade in credits generated within their borders.

The details vary, but from Indonesia to Kenya to Honduras, the goals are the same: Governments want to retain more of the benefits of emissions-reduction projects, whether as revenue or as credit toward their own national climate goals.

"If you are a developing country and you have the right kinds of project opportunities, you've got a golden goose," said Mark Lewis, head of climate research at Andurand Capital Management.

For countries with dense rainforests, mangrove swamps or other natural carbon sinks, carbon credits are increasingly considered alongside valuable minerals and metals like gold, lithium or copper.

"Commodities markets have created the precedent," said Samuel Gill, president and co-founder of Sylvera, a carbon research and ratings firm. "It is almost inevitable that nations come to see and treat carbon as any other national resource."

That wake-up call has been prompted in part by a growing awareness that, as of now, governments and local stakeholders might receive just a tiny slice of the revenues made by foreign project developers, said Pablo Fernandez, chief executive of Ecosecurities, a project developer and investor.

For example, most of the €100 million in proceeds from one of the biggest offset projects, a forest-protection site called Kariba in Zimbabwe, were accrued by the Swiss developer South Pole and its Guernsey partner Carbon Green Investments. In Mexico, BP paid rural villagers a small fraction of the market value of the credits generated on their forest land, according to a 2022 Bloomberg Green investigation.

"I'm not saying it's the pattern of the market, but we do have some projects that are badly designed and badly executed," Fernandez said. "That leads to these situations."

At the same time, carbon credits have new value for emerging markets. Under the 1997 Kyoto Protocol, wealthy countries had emissions targets and could buy credits from projects in developing countries to meet them. The 2015 Paris Agreement introduced targets for all, developing countries included, effective from 2020.

This means governments now view the units not just of a source of revenue, but as a tool to meet their international obligations. "The Paris Agreement acknowledges emissions as sovereign liabilities," said Finn O'Muircheartaigh, director of policy and markets at BeZero Carbon, a research and ratings firm. "Countries are now recognising they also have sovereign assets, which are their ability to reduce carbon or sequester carbon."

The new sovereign trading market is being set up by the United Nations, with an accounting framework that prevents the same credit from being applied to more than one country's climate goal. That means countries will have to decide if and when credits produced within their borders will be made available for use by others and when they'll be used for national goals.

Though the details are still being fine-tuned, some countries have already begun to strike deals to ensure supply. More than three quarters of countries say they plan to or are considering using the UN carbon market to meet their targets, known as "nationally determined contributions".

"Adjusting the amount of supply going to NDCs, rather than offset markets, has big implications," according to BNEF , which predicts the voluntary offset market could reach US$1 trillion by 2037.

One of those implications will be regulatory change and, at least at the beginning, inconsistency from one country to the next. Last month, Zimbabwe announced its intention to retain 50% of carbon revenues generated there, effective almost immediately. Kenya is debating legislation that would provide local communities a 25% cut. In October, Tanzania introduced new rules governing the revenue split, but developers say they are still waiting for specifics.

Elsewhere, Papua New Guinea suspended new deals while it worked on regulation. Honduras put a moratorium on the sale of forest-based carbon credits, and Indonesia imposed conditions on the export of carbon credits.

Meanwhile, Malaysia has said it won't limit sales of offsets abroad. Ghana, often lauded for its regulatory clarity, recently struck a deal to sell credits to Switzerland. Possibly one of the biggest impacts on the market, however, will be China — the largest supplier of offsets — which is readying a revamp of its domestic voluntary market.

The Paris Agreement was "revolutionary" in the way it empowered every country to set its own targets and manage its own market, Fernandez said. But that is a bumpy and inconsistent process, he added: "Today, we are living with the problem of this."

Investors say they welcome moves to create clarity, stability and predictability in the carbon market. "Improved regulation — and the greater certainty that comes with it — represents progress," said Ana Haurie, chief executive of Respira International, a carbon finance firm. "By creating certainty around the cost, the market can determine whether it's a price worth paying."

The emissions trading industry welcomed the new regulatory frameworks that would bring more certainty for investors but warned policymakers not to be overzealous.

"The new frameworks and the degree of government interventions will determine how attractive individual countries are for investors," said Andrea Bonzanni, the director of international policy at the International Emissions Trading Association. "If we make things too difficult, there will be no international carbon markets."

Investors will pick projects in countries which offer the best risk-to-reward ratio, according to Benedikt von Butler, portfolio manager at Evolution Environmental Asset Management LP. It's "in a host country's self-interest to minimise political risk to attract more investments, which will also generate revenues for governments," he said.