29 January 2024: MPC unlikely to cut rates

This week’s meeting of the Bank of England’s rate-setting Monetary Policy Committee will almost certainly vote for rates to remain unchanged. The latest data that has been released for output, employment and inflation shows that although progress has been made, there is no incentive for a cut since rates appear to be sufficiently restrictive to see inflation fall, but not drive the economy into a recession.

Andrew Bailey and his colleagues from the Bank, who make up the permanent members of the Committee, will feel that one or possibly two further “pauses” will see inflation reach their target of 2%.

Fiscal policy changes are going to provide sufficient stimulus for the economy to see a period of growth, and with rates sufficiently restrictive to put downward pressure on inflation, there will be no need for a change in monetary policy.

It is expected that the four independent members of the committee, who have become irrelevant over the past few months, will begin to feel that a further hike is no longer necessary since any legacy of hikes that have taken place in the past will have faded.

Last week saw the release of PMI data which showed that output continues to improve, particularly in the services sector, which is the main driver of GDP.

The services PMI rose to 53.8 from 53.4 which contributed to the composite index rising to 52.5 from 52.1. Manufacturing output is still in contraction, but even in this sector, there was some improvement seen.

There is still an overarching view that the trade deals necessary to ensure that the UK still is a major trading nation post-Brexit are taking too long to come to fruition. The collapse of talks with Canada recently shows that although there has been progress, there are still no agreements in place with major trading nations like India and the U.S.

It was believed that a deal with Canada would be one of the easiest to achieve, but the acrimonious end to the latest round of talks makes a deal less likely.

It is somewhat ironic that a deal with the U.S. may be easier to achieve should Donald Trump be re-elected to the Presidency in November. Trump seems more positive towards the UK than Joe Biden, who wants to keep his nation’s relationship with the European Union, while Trump sees Britain as a more “malleable” potential partner.

It is, however, hard to imagine Trump striking up the kind of relationship with Keir Starmer that he had with Boris Johnson.

The pound trod water as the major G7 Central Banks are meeting to discuss interest rates over the next week. The ECB left rates unchanged last week, while the FOMC and MPC are expected to follow suit this week.

Sterling slipped to a low of 1.2596 but rallied to close at 1.2702, barely changed on the week.

The financial markets are almost 100% agreed that the FOMC will leave rates unchanged when it meets this week. However, there is a hope that Jerome Powell will provide a clue to his colleagues thinking about when the optimum time for the first cut will be to take place.

Powell himself is thought to favour a more prolonged pause, particularly given that fourth-quarter GDP data, which was released last week, showed that the economy is performing well while inflation, especially core inflation, remains “sticky.

The strength of the PMI data which was published last week points to an economy that is still forging ahead, which will allow the Fed to leave rates at their present rate of 5.50% for longer than was previously expected to ensure that when cuts do take place there will be no “flare up” in inflation.

The CEO of America’s largest bank, Jamie Dimon, is still seen as the single biggest critic of the level of interest rates. The head of JPMorgan Chase continues to talk about an economy on the verge of collapse. His judgement is based on the limits that are placed on bank lending by what he considers to be overzealous regulation.

He is another leader who will welcome the election of a Republican President, although the jury is out about his opinion of Donald Trump.

Dimon, far from seeing cryptocurrencies, like Bitcoin, as the future, sees them as the singular biggest threat to the banking sector.

The Fed’s median expectation for 2024 GDP is currently 4.6%, although it is expected that this will be revised at this week’s FOMC meeting.

Most pundits had March pencilled in as their prediction for the first cut in rates, but the robust performance of the economy and the fact that inflation is still above 3% could see that prediction delayed by at least one meeting.

A lot will be riding not only on Powell’s press conference this week, but also on the comments made by his colleagues once the meeting has taken place.

Unlike the ECB, there is a basic agreement amongst members of the FOMC regarding the future path of interest rates as the country becomes less regional in the spread of economic activity.

The dollar index still looks on the verge of a significant breakout to the upside, particularly as the Euro appears to have shed the protection in the underlying hawkishness of the ECB.

Last week, the Greenback rallied to a high of 103.81 and closed at 103.45, continuing a run of three consecutive higher weekly closes.

The outcome of last week’s meeting of the ECB’s Governing Council was entirely predictable, as Christine Lagarde spoke of her belief that any talk of interest rate cuts is premature, and that is the view of much of the Committee.

Lagarde who is seen as under pressure gave a report published last week that showed that she is unpopular with the staff of the ECB. The most severe criticism is that she sees the role of the President as a stepping stone towards greater political ambition.

She is also not considered to have in mind a clear path for the economy that she is sufficiently committed to.

The PMI data that was published last week painted a poor image of economic activity in the region and showed just how necessary the “shot in the arm” that would be provided by a rate cut would be.

Not only were the PMIs universally poor, but consumer confidence, which appeared to have bottomed out, has begun to weaken again.

The composite PMI combining both manufacturing and services output only saw a minor increase, while consumer confidence fell to -16.1 from 15 in December.

The President of the Dutch Central Bank, Klaas Knot, who had in the past been considered a hawk, seemed to have changed his views on interest rates according to recent speeches.

However, he has renewed his credentials as he spoke at the weekend of the need to see wage increases, which have been rising at well above the rate of inflation, moderate considerably before rate cuts can begin.

Knot weighed into the immigration debate that is still raging in the Netherlands when he also spoke of the important contribution that skilled foreign workers are making to the Dutch economy.

Any thoughts of a soft landing for the Eurozone economy appear to have been banished now, although with inflation falling and unemployment having plateaued, the conditions for a soft landing are still in place, it would be a brave man who felt able to make such a prediction.

The single currency lost ground last week as the market still believes that the ECB will cut rates “sooner than later”.

The Euro fell to a low of 1.0813 but rallied to close at 1.0854.

The cloak of invincibility it has been provided by a hawkish Central Bank is slipping, and as with the dollar, there is a growing feeling that a significant move lower could be about to take place.

Have a great day!