21 March 2024: Lower inflation may lead to a surprise rate cut

The rate of inflation fell by more than expected in February as last year’s energy price shock “fell off” the year-on-year numbers. The headline rate of inflation in February was 3.4 higher than a year ago. This was significantly lower than the rate of 4% recorded in January, and lower than the market’s expectation of 3.6%.

The data certainly keeps the idea of a summer rate cut “front and centre” in the minds of traders and investors and creates a small chance that the Monetary Policy Committee could cut rates at its meeting today.

However, although Andrew Bailey spoke recently of his conditions for a rate cut being less demanding than the market had previously expected, the Bank of England Governor has said on many occasions that any decision on interest rates will be based on trends rather than one of data points.

The data will certainly heighten the level of attention that today’s meeting will attract.

There was a marginal fall in factory gate prices. In February, Producer Prices were 2.7% higher than a year ago. That was better than the 2.8 rise the market had been predicting.

The Prime Minister and the Leader of the Opposition clashed in Parliament yesterday, as Rishi Sunak faced the Weekly session of the Prime Minister’s Questions.

The two primary areas of dispute were the Government’s handling of asylum seekers and the state of the economy.

On the economy, Labour Leader Sir Keir Starmer was critical of the lack of activity in the economy, which led to a recession late last year. Rishi Sunak countered by saying that the economy has “turned a corner” since January.

He pointed to the fall in inflation which will eventually lead to a cut in interest rates. This will reduce the burden on households which will be better off by close to £1,000 this year after the cuts in National Insurance Contributions made in the Budget.

Earlier this week, the Shadow Chancellor, Rachel Reeves, gave some insights into her Party’s plans when/if it is elected in the upcoming General Election.

Reeves dampened fears that she would significantly increase public borrowing to increase public spending. This has led to fears that the already high personal tax burden will be increased further. She has already committed to keeping the level of Corporation Tax unchanged, since any increase may lead to the country becoming unattractive to investors.

The Pound is still driven by the possibility that the rate will be cut later today. Yesterday, it jumped to 1.2787 versus the dollar as the Fed confirmed that it still expects to cut rates three times this year, as it left rates unchanged. It eventually closed at 1.2785.

The FOMC is in danger of becoming predictable. Gone are the days of successive Chairpersons, who “pull rabbits from a hat” to drive the economy forward.

Jerome Powell is a man who uses the skills he has to drive the economy more conservatively.

For that reason, no one imagined that following an extended period of advance guidance that was “borderline hawkish,” the committee would do anything other than leave rates unchanged.

The market had gotten ahead of itself when it was told that the Central Bank expected to cut rates three times this year, with more cuts to follow in 2025.

In the lead-up to the latest meeting, the market had assumed that with time running for cuts to begin, it may change the number of cuts from three to two.

However, with six meetings scheduled for the remainder of the year, there will still be ample time for three cuts even if they do not start until the June meeting.

Furthermore, once Powell and his colleagues agree to cut rates, there is no reason for cuts not to take place at three consecutive meetings, as they did when they were hiking rates, without having to wait to see if they slow the fall in inflation to any degree.

The Fed’s decision to keep rates on hold was based primarily on the employment data that has been published so far this year. Although the exceptional number of new jobs that were created in January has been revised significantly lower, the trend over the past three months is for the job market to still be “hot.”

Given the fact that headline inflation is still “sticky,” it was a prudent decision to leave rates unchanged.

The dollar index lost ground following what was a more dovish meeting than the market had been expecting. Jerome Powell’s tone overall was preparing the market for a series of rate cuts that will start in the summer.

The index fell to a low of 103.37 and closed at 103.40, although it currently remains in a consolidative phase.

Some of the more bearish comments that have been published recently depict the Eurozone as facing a “lost decade” as growth has almost disappeared from the region.

Although it has been faced with several “once in a generation” events like the pandemic and the first war in Europe since 1945, in some ways it has been its own worst enemy.

ECB President Christine Lagarde has been accused of putting her political aspirations ahead of the need for far greater control of monetary policy.

When she replaced Mario Draghi, he was undoubtedly a tough act to follow. He had been credited with single-handedly “saving the Euro” following his “anything it takes speech” in the wake of the 2012 financial crisis.

Lagarde has allowed matters to drift, especially around fiscal support in the wake of the pandemic. Having been “late to the party” when beginning the cycle of interest rates that ended last September, she has been accused of allowing inflation to take hold, a most heinous crime even in an immature Eurozone.

There has been speculation that if Angela Merkel had not been so stubborn in wanting Ursula von der Leyen as President of the European Commission the ECB may have got, in Jens Weidmann, a President who would have been far tougher initially in rising inflation.

Lagarde has often been depicted shrugging her shoulders as if she has no power over the will of the Governing Council.

Following the publication of the wage data for the first quarter, the ECB is going to need to perform a dovish pivot as a first step in restoring a level of growth to the region that can be built upon.

Several systemic changes need to be taken at both the national, and the “Federal levels” for the Eurozone to return to its place as the world’s third-largest economy.

The fall in productivity has been spectacular and can be traced back to how individual Eurozone members remain protective of their interests ahead of those of the entire “project.”

The Euro was positively affected by the more dovish than expected outcome of the FOMC meeting. It climbed to a high of 1.0922 and closed at that level. It is likely that since nothing has materially changed, the market has given another opportunity for bears to re-establish short positions in the single currency.

Have a great day!