15 December 2023: Rates remain at 15 year high

Following the conclusion of the latest meeting of the Monetary Policy Committee, Andrew Bailey pushed back against market expectations of a series of rate cuts early in the New Year, commenting that rates will stay high sufficiently long for inflation to return to the 2% target set by the Government.

Bailey said that both the Bank of England and the Treasury are pleased with the fact that inflation has retreated from more than 10% in January to 4.6% currently, but it is way too early for a victory to be declared yet.

He went on to warn listening journalists that the committee won’t hesitate to raise rates again if inflation flares up in the New Year, irrespective of the reason.

The Committee voted by a majority of 6-3 to leave interest rates unchanged. Megan Greene, Jonathan Haskell and Catherine Mann all voted for a further hike.

Although the latest data points to a slowdown in the economy over the final quarter of the year, culminating in a recession, the Bank clearly feels that inflation remains a bigger issue despite comments that it will still be driven by the data. The latest comments portray a view that they will continue to be selective over which data they are driven by.

Despite continued high interest rates and inflation remaining close to 5%, consumer confidence rose for the second consecutive month with the research company Gfk, which compiles the data, commenting that the public will be inclined to spend this Christmas. It is hard to decide whether this attitude is born out of a genuine belief that things are improving or a feeling of defiance.

Wages continue to rise at a faster rate than inflation, although the Bank of England will want to be clear that it doesn’t want the UK to develop into a high inflation economy with wages continually rising faster than prices.

Market expectations are for official rates to be cut to 4% over the course of the next twelve months, but this will depend on inflation continuing to fall. It will take until well into the second quarter of next year before the rate hikes have already taken place to work their way into the economy, by which time it is hoped that wage increases will also have moderated.

The changes announced by Jeremy Hunt in his Autumn Statement have also provided a moderate boost to consumer confidence, with it becoming apparent that a cut in direct taxation is likely in the Spring.

The more hawkish than expected outcome of the latest MPC meeting gave a further boost to the pound. Yesterday it rose against the dollar to a high of 1.2794 and closed at 1.2771 as the market perceived the FOMC is closer to cutting rates than the MPC.

Clearly, the cost of holding a short position in Sterling for now outweighs the relative state of the two economies.

Now that the three major G7 Central Banks have concluded their final meeting of the year, the FOMC has become the most dovish, signalling that it feels confident that it will be able to cut interest rates relatively soon, but more importantly at a time of its own choosing.

Both the MPC and ECB appear to still be concerned about the potential for inflation to return, but the economies of both the UK and Eurozone look far more likely to suffer a significant downturn in economic activity than a concerted rise in prices, particularly core inflation.

It is well known, indeed, Jerome Powell has referenced it many times, that any fall in inflation is not expected to be linear given the number of variables that contribute to the data, but the latest meeting of the FOMC and the comments that followed confirmed a soft landing many observers base case for the economy.

The Fed Chairman was fairly neutral in his comments following the meeting, but that in itself was a significant change in his attitude, even since the Committee voted for a pause in rate hikes. Even saying that it is unlikely that rates will need to be raised again is a significant step forward.

Even if the data for December shows that both wages and inflation are no longer rising and employment is continuing to moderate, the Fed will most likely feel sufficiently confident to declare that a soft landing has been achieved.

It is something of a triumph for Powell’s tenacity that the U.S. Treasury now feels that a soft landing is well within the grasp of the economy, particularly when it was only at the start of this year when several prominent economists were predicting that headline non-farm payrolls will have slipped into negative territory by the beginning of the third quarter and the economy would be in recession by now.

The Fed Chairman has managed to convert the rest of the FOMC into a belief there is a “new normal” following the end of the Pandemic, which has led to an economic resilience which is able to withstand higher interest rates.

The dollar index has so far reacted badly to the more dovish outlook from the Fed. Yesterday, it fell to a low of 101.76 and closed at 101.94.

The ECB is still concerned about a return to the levels of inflation that caused it to hike rates to record levels, and has, so far, encouraged it to feel that any rate cuts will not be made for some considerable time.

It is unclear whether Christine Lagarde genuinely believes the statements she has made following recent meetings of the ECB’s Governing Council, or if she is simply reciting a carefully worded text that has been agreed by the entire group.

It is hard to ignore the data that has been released over the past two quarters. It is now a fairly common belief that rates were hiked unnecessarily in September and maybe also in August, after members of the Council returned from a month-long holiday and decided that inflation was still too high.

It may have been better to pause in August to better assimilate the hikes that had already taken place, but it appears that the more hawkish members were unable to take on board the theory that hikes were taking longer to work their way through into the economy and that that progress was hampered by the differences in fiscal policy which led to a dampening of their effect.

It has been made abundantly clear that the ECB, or more correctly several members of its Governing Council, do not subscribe to the idea of a new normal, with the economy having been subject to a series of radical policy initiatives almost since the financial crises that took place over ten years ago.

In the case of the Eurozone, the new normal will most likely be a period of calm, with no emergency measures either being enacted or on the verge of being so.

At her press conference yesterday, Lagarde would only commit to the fact that price pressures are beginning to ease, which is in spite of inflation declining rapidly. She continued to refuse to accept that the ECB has now defeated inflation, although she did concede that it is winning the fight.

There are always hawkish caveats to official statements that betray a level of concern over inflation that is longer valid.

It seems that a mild recession is still acceptable, but such a state of affairs could easily deteriorate in several member nations to a point where support is again necessary.

The Euro has rallied considerably over the past few days and if it is able to maintain this level into the end of the year it will contribute to a further easing of inflation, but, equally, will harm exports.

It rose to a high of 1.1009 yesterday and closed at 1.0992.

This is a crucial level for the currency and if it fails to break through resistance around the 1.1020/30 level, its fall could begin again and be fairly rapid.

Have a great day!