The death of trussonomics and the fight against inflation – Opinion Thomas de Caluwe

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Opinion Thomas de Caluwe

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US inflation numbers are causing high EUR/USD volatility, certain ECB members are more likely to talk about rate hikes continuing into 2023, and UK Prime Minister Liz Truss is firing her Finance Minister Kwasi Kwarteng. The political risk for the British pound is high.

On Friday, US inflation numbers came out again for September. While the official figure fell for the third straight month, core inflation (which excludes volatile items such as energy and food) rose to 6.6%. This is the highest level in decades. As a reminder, this number is important as the Fed partially bases its interest rate adjustment on this number. The higher the inflation rate, the faster interest rates must rise to combat it.

EUR/USD promptly fell to $0.963, but recovered with impressive speed to $0.98. The reason for the setback is that the Fed is guaranteed to raise 0.75% at the next meeting. High inflation isn’t going to change that much. This week has been relatively quiet in terms of data, in preparation for the ECB meeting next Thursday. Last week, a short piece was devoted to central bank policy in 2023. Most analysts estimate that the policy rate will be around 2%. The goal is to reach a ‘neutral’ interest rate, where the economy neither stimulates nor slows down.

ECB bankers want to go further with interest rates
However, there are committee members within the ECB who want to go further. Eg. states the director of the Belgian central bank, Pierre Wunsch, that he finds a deposit rate of 3% ‘not unreasonable’. Martins Kazaks, his colleague from Latvia, also sees no reason to take a break after the meeting in December. Wunsch also warns against the dangers of divergent monetary and fiscal policies, which complicate the fight against inflation. Most Member States in Europe protect their residents from high energy bills by means of subsidies. This protects households’ purchasing power, which contributes to inflation.

The two most recent rounds of decisions show that the so-called hawks (the denominator for the ECB members who favor high, fast rate hikes) are currently in control. Their view is supported by the fact that their in-house economists have consistently underestimated inflation in the recent past. If it turns out that these members get more and more support for their ideas, it could give the euro a new impetus.

British political chess game
In Britain, the game of political chess continues to develop at breakneck speed. Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng’s tax plan was unilaterally rejected by the market, which expressed its opinion by sinking the pound to its lowest point since the 1980s (against the dollar). In an attempt to ease the pressure on her person, Truss thanked her minister and political ‘partner in crime’ Kwarteng on Friday for services rendered. He will be replaced by former health secretary Jeremy Hunt. Kwarteng has the dubious honor of being the short-lived finance minister since Ian McLeod, who died of a heart attack a month after his appointment in 1973.

But the prime minister is not out of the woods yet, and her situation remains uncertain. After all, she and Kwarteng were on the same page in terms of politics and ideology. Throwing him out therefore means partially abandoning her economic plan (the so-called ‘Trussonomics’) that supports her premiership. In the fifteenth embarrassing twist, the new minister Hunt did not rule out the possibility of more adjustments. His statements about restoring credibility are aimed at regaining market confidence. Whether it has succeeded will be seen from the government bond market this week. It had risen alarmingly again by the time it closed on Friday. Until stability returns to that market, risks to the pound will also remain high.

Thomas de Caluwe

Thomas is a Benelux currency trader at Argentex in Amsterdam

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