Bullion Bulletin: The tethered mustang

Central banks of the Eurozone, the UK and the US all put up interest rates last week – the Federal Reserve by the (widely expected) 0.25%, taking the federal funds rate to 4.5%-4.75% – and the Bank of England (BoE) by 0.5%, putting the UK’s base interest rate to 4%. The European Central Bank (ECB) joined in on Thursday, putting the Eurozone’s base rate up by 0.50% to 2.5%.

They do this to drive down demand in the economy; the aim is to extinguish high inflation. Making borrowing money more expensive is a blunt instrument with time-lags measured in months of even years. The risk is that central banks raise rates too high and consequently don’t just slow demand but slash it so much that an economy moves into recession, with all the associated downsides, such as rising unemployment rates, more expensive mortgages and increased public unhappiness over the cost of living. It’s a perpetual tightrope act, made all the more tricky by these central banks aiming to achieve 2%/year inflation.

The leadership of all three banks showed a determination to quash inflation. Jerome Powell, chairman of the Federal Reserve in the US, where inflation in December was 6.5% (versus 7.1% the previous month and a four decade high in June of 9.1%) said “we are going to be cautious about declaring victory and sending signals that we think the game is won, because we’ve got a long way to go”. Andrew Bailey, governor of the BoE, said “we need to be absolutely sure that we really are turning the corner on inflation”. Inflation may be cooling in all three zones but only very slowly. The UK’s official rate (from December) is 10.5%, close to its highest in more than four decades.

Central banks are having a tough time figuring out the basic direction of their economy. With interest rates in the US at their highest level since September 2007 and even apparently well-paid Americans struggling – an end-December survey found that 51% of Americans earning above $100,000/year said they live from one pay cheque to the next – the signal to the Fed should be that interest rate rises have reached recession-point. But other data says the US labour market remains very tight – some 7% of jobs are unfilled while the unemployment level is 3.5% and recently was at an historic low. Moreover those in work are working on average 33 hours/year less than they did in 2019. In the UK, the story is similar; more than 20% of the working age population is “economically inactive” (neither employed nor looking for work).

Financial markets as usual immediately tried to guesstimate what the banks’ next moves might be. Opinion was divided as to whether interest rates will go even higher in the US, even though Powell said further tightening was on the cards. The ECB said it would “stay the course” on rate rises but the BoE’s rate setting body, the Monetary Policy Committee voted seven to two in favour of this latest rate rise, raising markets hopes that the peak rate for the UK is in sight.

There are signs that the US may escape a serious recession, although alarms are ringing about a “second wave” of inflation being imminent – medical costs are set to increase at the highest rate in 14 years. As for the Eurozone, Spanish inflation surprised many by going marginally higher in January. In the UK, a de facto general strike (500,000 people walked out) on 1 February spoke of deep anger among public sector workers at their wages being eroded by inflation – this is a problem without an easy solution.

Gold futures prices rose 1.3% (to $1,968.30) on Powell’s comments after the US rate rise, as the market detected a willingness to be less drastic with interest rate rises. Inflation appears to be calming, but appearances can be deceptive. Like a tethered mustang, gold seems to be champing at the bit – but it will have a while to wait.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.