2 February 2024: The 2% inflation target is meaningless

In his press conference following the latest Monetary Policy Committee meeting, Bank of England Governor, Andrew Bailey, admitted that an interest rate cut is “under review”. Surely that is the purpose of the regular meetings of the Committee, even when the outcome is as certain as is currently the case.

Yesterday’s meeting saw six votes to leave rates unchanged, two votes for a hike and one for a cut.

The Changes from the last meeting were that Swati Dhingra voted for rates to be cut after voting for no change in December, while Megan Greene changed her vote from hike to no change.

Catherine Mann and Jonathan Haskell both voted for a hike, just as they did in December. True to form, the five permanent members of the committee voted, “en bloc” for no change.

Over the next month, the four independent members will no doubt take the opportunity to explain to the market their reasons for voting as they did.

More than sixty Central Banks globally have a 2% target for inflation, which they adhere to, to a greater or lesser degree. It is interesting to note that the 2% figure is completely arbitrary and has no scientific reason to exist, and yet there is no discussion of a change to the target at all despite the evolution of the global economy which is subject to almost constant change.

A layman would expect there to be a great deal of empirical evidence, particularly with nations like Japan with historically low inflation and several nations with inflation that is significantly higher sticking slavishly to the 2% target.

The Opposition has begun to lay out its plans for the economy should it win the election.

Rachel Reeves, the Shadow Chancellor, addressed a meeting of business leaders yesterday in which she “wooed” her audience by saying that, as Chancellor, she would cap corporation tax at its current level of 25% and may consider a reduction to “boost competitiveness”.

When interviewed after her speech, Reeves dodged a question about the Labour Party’s commitment to a twenty-eight-billion-pound pledge to invest in green energy initiatives. The “pledge” has been watered down to being more of a vague expectation than a pledge in recent weeks.

Reeves hid behind the need to adhere to fiscal rules when asked about her commitment to this policy yesterday.

The market took an opportunity to buy Sterling in the wake of the no-cut decision from the MPC. it rose to a high versus the dollar of 1.2755 and closed at 1.2747.

Jerome Powell believes that the data that will be published later today will show that the jobs market in the U.S. remains strong, despite interest rates having been kept at historical highs now for several months.

Anyone clinging to the idea that even though rate hikes were ended following July’s meeting, that they are still “working their way into the economy” would expect that some effect on employment would be seen by now.

Most market practitioners believe that the FOMC paused, then ended, rate hikes at exactly the right level to see inflation continue to fall while allowing new jobs to be added at a close-to-average rate.

Powell, yet again, stopped short of either announcing that a soft landing had been achieved or declaring victory over inflation. However, that is more due to his cautious lawyer’s attitude than any concerns over the economy.

The next meeting of the FOMC will take place on March 19/20, and it is expected to be similar to the latest meeting, given that Powell has already poured cold water on any expectation of a cut in rates.

Between now and then, the minutes of this meeting will be published, on February 21st, and a multitude of Committee members will have their say on the economy, most likely reiterating that the meeting at which a cut in rates will take place will be the one in June.

By the time that meeting comes around, the market will be in a frenzy of expectation.

The confidence that is being shown in the economy, especially the retail sector, was emphasized by Walmart, one of the largest retailers in the country, which announced recently that it plans to open 150 new stores in all geographic locations of the country.

However, there is a jolt “in the works” for the economy as likely Presidential election candidate Donald Trump floated plans to attach a 10% tariff to all U.S. imports to encourage investment in “home-grown” manufacturing.

The data for lay-offs that was published yesterday showed a surge to its second-highest-ever level. This was taken by those who are bearish on the economy to show that the slowdown that they have predicted is beginning.

The “acid test” will be delivered later today when the January employment report is released. It is predicted that 180k new jobs will be created, down from the 216k in December.

The dollar index lost ground yesterday despite the hawkish overtones of Jerome Powell’s post-FOMC comments. It fell to a low of 103.01 and closed at 103.06.

Prompted by the fall in inflation in the region’s two largest economies, Germany and France, inflation across the entire Eurozone fell in January.

Although this data will have encouraged the most optimistic market commentators that a cut in interest rates is imminent, the Governing Council will most likely wait until it has seen the first quarter wage data before committing to the beginning of rate cuts.

It is likely that similarly to when rates were rising, the ECB would prefer a gradual programme of rate cuts to portray an orderly fall which will soothe any market concerns about the reason for the cuts.

Philip Lane, the ECB’s Chief Economist, believes that two areas of the economy need to be addressed before rate cuts can begin,

The first is that firms of all sizes need to look at their profit levels and where possible reduce their margins to avoid accusations of profiteering, while wages are still rising too quickly for the ECB’s liking.

The latest data shows that wage increases are well more than the rate of inflation, and while there may be some “overhang” given the pace at which prices have fallen recently, wage claims should now be moderating.

Lane went on to say that overall inflation has fallen more rapidly than the ECB’s models had predicted and while that does not mean that interest rates should be cut yet, there is a more positive attitude to cuts taking place than was previously the case.

Lane still believes that given that the Q1 wage data will have been published and digested by the Governing Council, the June meeting would be the one where rate cuts would be “seriously discussed”.

Donald Trump’s floating idea of tariffs on all U.S. imports of finished goods echoed what Christine Lagarde said recently about the threat posed economically to the region by a Trump victory in November. The 2022 figures show that the Eurozone exports close to twice as much in dollar terms to the U.S. than it imports, rendering any tit-for-tat measures pointless.

The single currency saw a rare positive day versus the dollar yesterday. It rallied to a high of 1.0874 and closed at 1.0871.

Have a great day!