3 November 2023: Bailey – Much too soon to lower rates

The Bank of England’s Monetary Policy Committee voted to leave rates unchanged at its latest meeting that ended yesterday.

Andrew Bailey, The Bank’s Governor, told reporters that he doesn’t expect to see meaningful growth in the economy until 2025.

The economy is teetering on the edge of a recession but despite this gloomy outlook, Bailey said that it is far too early to be considering rate cuts given the elevated level of inflation. He expects rates to remain high for an extended period, an outlook that he shares with the Central Bank heads of other G7 members. However, both the U.S. and Eurozone have seen their headline rates of inflation fall significantly recently while the UK enjoys no such luxury.

The market now sees the chance of a recession by the middle of next year as 50/50. This will not please Rishi Sunak as he prepares for a General Election with his Government trailing so far behind the Opposition that it is almost out of sight.

The weakening outlook for the economy has been highlighted by the economic data that has been published recently, with employment seemingly now being affected by the elevated level of the base rate of interest.

The language used in the statement echoed that of the Chair of the Federal Reserve the previous day and amounted to what City economists are calling a “hawkish hold”.

The September meeting of the MPC voted 5-4 in favour of leaving interest rates unchanged, and it is probable that the outcome was the same this time around.

Although Bailey sounded an optimistic note recently, saying that he expects inflation to have slowed markedly in October, the headline rate is still expected to be closer to 4% than 3% by next March. It is unlikely that inflation will be back to the Government’s target level of 2% for another two years.

While some of his colleagues believe that the rate increases that have taken place so far are still feeding through into the economy, Bailey believes that their effect is now being seen with demand slowing. Unemployment is beginning to rise and is expected to reach 5% in early 2025 from its current level of 4.2%.

Personal finances have been hit by a double whammy as mortgage and rental costs have risen while disposable income has been hit by continuously elevated levels of inflation.

It is increasingly difficult to predict how the economy will look in a year’s time with the election, conflicts in Ukraine and the Middle East likely to push energy costs up and a general slowdown is expected in the global economy.

Despite the all-around gloomy outlook, the pound made ground against the dollar yesterday as at least the support provided by high interest rates stays.

It rose to a high of 1.2205 and closed at 1.2203.

Jerome Powell wants to remain hawkish over interest rates following the most recent meeting of the FOMC. However, in relaying the news that his colleagues had again voted to leave rates on hold against an economy that grew by 4.9% between July and September his words and deeds do not match up.

Traders are now increasing bets that the Fed has ended its cycle of rate increases as inflation has reached 3.7%. The data for October will be published on November 14th, and it is expected to have fallen again.

Bets are increasing that the next move in interest rates will be a cut, but that is not likely to take place until at least the second half of next year.

The market’s risk appetite has begun to rise again as the market now strongly believes the rates in the U.S. have peaked. Powell is fighting a lengthy battle with traders and investors to persuade them that another hike is possible although the medium-term outlook for the economy is unclear.

The Fed Chairman is sounding more positive about the outlook for the economy but appears to be one of two meetings “behind the curve”.

He continues to credit the consumer with greater resilience than may be the case as consumer confidence fell moderately for the third consecutive month.

It has been the case for several months that the publication of the employment report is set to be pivotal and provide a watershed for a downturn in the economy. So far that has been the case and although the headline rate of new jobs created in October may only be half that seen in September, the report is likely to remain strong despite tighter monetary policy.

A decline in wage increases from 4.2% to 4% while the unemployment rate is unchanged at 3.8% is still positive. It used to be a truism in the market that a 5% unemployment rate denoted as close to full employment as it was possible to get. Now, a rise to 5% would be considered a harbinger of a significant slowdown.

The dollar index reacted to the improvement in risk appetite and the possible end to rate hikes by losing ground yesterday. The fall is expected to be temporary and is likely to attract “bargain hunters.

The index fell to a low of 105.81 but recovered to close at 106.14.

The uncompromising position adopted by the ECB as it became clear that the Eurozone economy was rushing headlong towards a recession is now bearing fruit with a significant fall in inflation having been recorded in October.

There are likely to be those on the Governing Council who feel that rates should have continued to rise until inflation had reached the Central Bank’s target of 2% even if it breached that level.

In the end, common sense prevailed. Data released recently showed that the major economies of the Union are perilously close to contracting over the requisite period for a recession to be declared.

A recession is two consecutive quarters of economic contraction. This is both clear and an acceptable measure. When there is talk of an economy being in a “technical recession”, that is little more than “central bank speak”. The definition is clear, although long before a recession is declared the “writing is generally on the wall”.

The ECB’s obsession with inflation means that rates were probably increased once or maybe twice more than they needed to be. A lot rests on the premise of how long it takes for rate increases (or cuts) to work their way through into the general economy.

If it is generally acceptable to believe that some areas of the economy are more susceptible to changes in interest rates than others, then it stands to reason that in general changes in interest rates do take a period of time to be effective overall.

The ECB chief economist, Philip Lane, showed an uncharacteristically optimistic side yesterday, by commenting that he feels there is still a case to be made for a soft landing for the Eurozone economy.

Although lending has slowed down to a trickle, Lane doesn’t see companies, particularly SMEs bracing themselves for a recession.

The fall in inflation together with the end of the ECB’s cycle of rate hikes mean that there is an opportunity for companies to take stock. There has been no increase in unemployment across the entire region which, Lane feels, is also a positive.

The Euro responded to a weaker dollar by climbing close to its short-term level of resistance yesterday. It reached a high of 1.0667 but failed to consolidate at higher levels and drifted back to close at 1.0621.

Have a great day!