24 October 2023: Rates likely to remain on hold

While the focus of the Bank of England stays heavily skewed towards inflation, there are clear concerns that with interest rates at or close to being restrictive on growth that another rise may tip the economy into a recession.

With several indicators already in negative territory Andrew Bailey added weight to the argument for a continuation of the pause in rate hikes, commenting recently that he expects inflation to fall “markedly” this month.

The question now is can the MPC act preemptively without confirmation of the drop in inflation and pause despite the country still having the highest rate of inflation in the G7.

The Market believes they will. Several commentators now feel that rates are at the point where, as their effect works its way through into the economy, inflation will begin to fall “naturally”.

Today sees the release of the September employment report with data for wages having already been published, the expectation is for the claimant count to rise by around 2.5k, although the unemployment rate is expected to remain at 4.3% for the three months to August.

It is a tough call for the MPC next week with a majority of the independent members voting for a hike at the last meeting as well as one of the permanent members, Jon Cunliffe, the Deputy Governor for Financial Stability.

The data released since the last meeting doesn’t lead to a conclusion that Catherine Mann, Megan Greene or Jonathan Haskell will be moved to vote for a pause, so a lot will depend on the level of faith that the Governor has in inflation falling and by how much.

The Chancellor of the Exchequer, Jeremy Hunt, while preparing to deliver his Autumn Statement pt Parliament next week is preparing for the worst as the economy with its newly found freedoms to trade with a far wider group of partners, is hit by concerns over the level of volatility created by the ongoing conflict in Ukraine and the war between Israel and Hamas.

There is a great deal of uncertainty surrounding the resilience of the UK to withstand any major shocks in the short to medium-term, with Hunt’s hands tied.

He feels unable to deliver any tax cuts yet given the poor state of the nation’s finances with the PSBR at record levels and turmoil increasing in the bond market.

Sterling rallied yesterday on the back of a weaker dollar, although it is still under pressure versus the Euro.

Against the dollar it rose to a high of 1.2258 and closed at 1.2248. Versus the single currency, it fell to a five-month low of 1.1459, before recovering to close at 1.1479.

Since it began to pause its cycle of interest rate hikes in June, the Fed has been telling the market that it can afford to be data dependent when making decisions about future monetary policy.

If that is truly the case, the decision at next week’s FOMC meeting should be straightforward.

Given the continued strength of the employment market, which created over 300k new jobs last month and the newly found stubbornness of the inflation data, a hike should be the expected conclusion.

In a major interview last week, Jerome Powell said how he was amazed by the resilience being shown by the economy to the major shocks that have taken place to the global economy since the cycle of strikes began.

He has been a hawk about interest rates since his second term began and has not materially changed his view as inflation has moderated. He is committed to seeing the headline rate of inflation back at the Fed’s target of 2% and appears to be prepared to risk a mild recession to meet that goal.

A recession is no longer the base case of most commentators and economists, with several Wall Street banks seeing growth of 2.1% this year, although it may moderate to around 1% in 2024.

It is unlikely that Powell will be granted his wish to see inflation at 2% any time soon. Inflation is projected to fall to 4% this year and 2.5% next year. While there are calls to raise the inflation target in the UK, no such move is expected in the U.S. although Presidential Candidate Mike Pence has been studying the Fed’s overall responsibilities and targets.

The rout of the bond market continues with the yield on the benchmark ten-year treasury bond reaching 5%, its 2007 high. It drifted back later in the day, but with an FOMC meeting just around the corner, and the Fed’s preferred measure of inflation due for release this week, the market is still on high alert.

The dollar has reacted poorly to the rise in long-term interest rates. The index fell to a low of 105.51 and closed at 105.59. There is significant support between 105.30 and 105.40. It is probable that this will hold unless there is significant negative news about the economy or the situation in Israel.

The Governing Council of the ECB is not interested in a pause in interest rate hikes since the general feeling is that if they pause in the knowledge that inflation is still “too high”, and they will have to revisit the strategy at a later date they risk losing control.

For that reason, although there is a growing view that a pause will be announced on Thursday, many commentators believe that rates will be hiked again by fifty-basis-points.

With interest rates bordering on restrictive, although Christine Lagarde believes they are already well past that point, there seems to have been little point to a constant diet of twenty-five-point hikes.

Having hiked at ten consecutive meetings taking rates from zero to 4%, the Central Bank may have “missed a trick” by not increasing the increment of the hikes.

The “narcissistic” tendencies of each individual member have meant that the more hawkish members of the Governing Council have needed to temper their demands for higher rates to appease the more dovish and by coincidence more indebted nations.

It is perhaps ironic that while the more hawkish nations like Germany, Austria, and Latvia are still eyeing stagflation, the traditionally weaker economies like Spain, Greece, and Ireland are beginning to exhibit levels of growth that are close to trend.

Data for consumer confidence was published yesterday, and it showed that although sentiment weakened marginally, it was not as bad as had been predicted.

There is no sign of a “light at the end of the tunnel” for consumers who have seen energy prices skyrocket as shortages of essential foodstuffs become scarce.

There is a fear that there may be another energy shock coming with prices increasing as winter demand begins. Concerns are also rising about potential sabotage of the pipelines that bring gas to the region to Russia.

The euro is gaining from the recent weakness of the dollar. The single currency’s only “crutch” is the potential for a narrowing of the interest rate differential.

The euro closed at 1.0669 yesterday, having reached a high of 1.0678.

Have a great day!