10 April 2024: Bredon still sees inflation as a danger

The second half of this year is expected to see a significant rise in volatility in financial markets as G7 Central Banks begin to make good on their commitments to cut short-term interest rates.

Several members of the Bank of England’s Monetary Policy Committee have “pledged” that if inflation continues to fall, and there is no spike in wage demands, cuts will begin in the current quarter.

The Bank’s Chief Economist, Huw Pill, and two of the independent members of the committee remain slightly more hawkish than their colleagues regarding the cuts’ number and incremental value.

Pill wants to be “convinced” that inflation will not flare up once cuts begin, although he has not provided any criteria for that to happen.

Catherine Mann and Jonathan Haskell both see the economic risks as being balanced. They believe that inflation is not yet under control while growth is beginning to become more easily attainable, although geopolitical conditions are still a concern.

For this reason, they both voted for rates to remain unchanged at the most recent MPC meeting. Even this was a significant event since both had consistently voted for a rise since the overall decision of the Committee had been to pause the cycle of hikes.

Sarah Breedon, the newest permanent member of the Committee, spoke earlier this week of her view that workers need to continue to moderate wage demands to see inflation continue to fall. She agreed with Andrew Bailey that the Bank does not need to see inflation reach its 2% target for rate cuts to begin if there is sufficient data available to confirm the trend.

Breedon’s views are likely to be shared with her colleagues, and for this reason, the market now sees the June meeting as the most likely at which rates will be cut.

Shadow Chancellor of the Exchequer, Rachel Reeves, who stands a better than even chance of becoming the country’s first female Chancellor following the General Election, has had several personal issues to deal with over the past few weeks, The Government have demanded that the police reopen a case that they had earlier dropped concerning Reeves’ tax affairs following the sale of a house that she had purchased from her local council, while the Parliamentary Ethics committee are looking into her expenses claims for a second residence.

These issues have caused her recent comments on her economic plans to gain less attention recently, which is the intention of Government MPs.

Sterling is still “trapped” in a narrow range, although it did spike a little yesterday, making a high of 1.2709, on a rumour that the Bank of England may no longer commit to three interest rate cuts this year. As the rumour was found to have no basis, the pound drifted back into its recent range and closed at 1.2678.

The publication of the minutes of the latest FOMC committee meeting later today will be of more relevance to the market that they have recently, for the simple reason that the market is still awaiting any concrete news on when rate cuts will begin and for this reason has become trapped in narrow ranges, driven only by Commercial interest.

This has been a period of uncommon unanimity among Fed policymakers, with no formal dissents at a monetary policy meeting in two years. But that could soon change. Jerome Powell has been a constant voice for caution on when rates will be cut, citing the “stickiness” of the core rate of inflation.

This is even though Personal Consumption Expenditures, his preferred measure of price increases, have been falling constantly.

His colleagues who represent Regional Federal Reserves on the Committee have varied their opinions according to the data, which is the essence of being data-dependent.

The relative strength of the economy, particularly the continued creation of a considerable number of new jobs every month, and the level of GDP have caused two, in particular, to become significantly more hawkish in their outlook for monetary policy.

Both Neel Kashkari from Minnesota and Raphael Bostic from Atlanta have questioned the market’s assumption that there will be three, or even four rate cuts this year.

These are two highly experienced members of the FOMC, and the market would do well to consider their views seriously.

Kashkari was quoted recently as saying “If we continue to see inflation moving sideways, then that would make me question whether we needed to do those rate cuts at all.” At the same time, Bostic chimed with Kashkari’s view, commenting that he sees only one rate cut near the end of 2024 as justified, not the three embraced by most of the policy committee.

There are also dissenting voices being heard from Fed Governors, who are permanent members of the FOMC. No Governor has voted contrary to the views of the Fed Chairman since 2005.

Furthermore, every vote since the Fed began to hike rates in June 2022 has been unanimous.

The dollar index is still in the doldrums, but any further sign of dissent among FOMC members may increase volatility. The risk is currently heavily skewed towards the upside.

Yesterday, the index fell to its lowest level since March 21st, making a low of 103.88. It recovered late in the day to close at 104.11.

Most previews of the meeting of the ECB’s Governing Council, which is taking place tomorrow, see a straightforward decision, with the Committee opting for another pause.

In Christine Lagarde’s press conference, she is likely to use remarkably similar language to her previous two speeches, in that the Governing Council continues to be data-dependent in its policymaking.

The market is of the overwhelming view that the ECB will cut rates at its June meeting, particularly as independent surveys point to wage increases having fallen sharply during the first quarter of the year.

While there has been no official confirmation that wages will determine the ECB’s path, there have been enough oblique comments from even the most hawkish members to convince market commentators and practitioners.

Christine Lagarde has been criticized in the past for second-guessing the mood of the Council and will walk a tightrope tomorrow between hinting about a cut at the June meeting without saying so and retaining data dependency.

It is interesting to note that if wage data is still too strong for the ECB’s liking, and the vote was for no change in June, the Hawks may be persuaded to change their view on both the number and size of any future rate cuts, given the pickup in economic activity that has been seen over the past month or so.

Although it has needed to be “bailed out” by its Northern Neighbours, primarily Germany over the past ten years or so, Southern European States are becoming the engine behind a nascent recovery in the Eurozone economy.

The recovery of the economies of Spain, Italy, and Greece has placed the traditional growth engines of Northern Europe in the as they continue to struggle with systemic changes that their economies desperately need.

It may well be that the recovery in tourism revenues gives Southern Europe a platform to build upon, and they are embracing the possibility.

Italy may have to address its woeful fiscal position at some point, but for now, it along with its neighbours is content to “make hay while the sun shines.”

The euro, with other G7 currencies, is currently seeing the calm before the storm as Central Banks gear up for changes to monetary policy. The common currency has stayed in a narrow range between 1.0950 and 1.0750 for the better part of a month, but that will not last much longer.

Yesterday, it fell to a low of 1.0847 and closed at 1.0857.

Have a great day!