11 April 2024: The IMF warns the BoE over rates

The Labour Party has a problem.

In the recent past, it had to do very little other than “sit back” and watch as the Conservative Party came close to tearing itself apart. It felt like backbench Conservative MPs were doing the hard work that Labour should be doing to pit itself forward as a viable Party to lead the country for the next five years.

British politics appears to have a finite tolerance for political dogma. It happened to both Thatcher and Blair, two of the more resilient Prime Ministers of the modern era, and it is happening now to the present Government, despite the issues that Cameron, May, Johnson, Truss, and Sunak have faced driven by Brexit and the Pandemic.

Towards the end of last year, Rishi Sunak’s Cabinet resembled a rabble, seemingly accepting its fate to face years in the political wilderness that is opposition.

However, since the turn of the year, there has been an almost inevitable improvement in the state of the economy, since the recession that began in the final two quarters of 2023 ended as quickly as it began. There has been no economic miracle, it is more a case of the economic cycle reaching its nadir, and while the nascent recovery owes nothing to the efforts of Sunak and Jeremy Hunt to fan the flames, neither they nor the Bank of England can take any credit.

Sunak, first as Chancellor, then Prime Minister has resembled a centre-left politician resisting tax cuts, and even raising corporation tax while Johnson’s Cabinet was in open revolt.

Now, the country has reached the point where an election, in terms of the political calendar, is imminent and voters will begin to ask, “What is going to change under Labour?”

They do not, to use Theresa May’s words, have a “magic money tree”. They have been fiercely critical of the level of personal taxation under the present Government, so further hikes are out of the question.

The two most significant issues it faces are NHS waiting lists and immigration. Neither will be solved by “throwing money at them”, so the question remains, “Are Starmer, Rayner and Reeves going to squander the opportunity” by being timid and tentative or do they have the policies to take the country forward at anything other than the snail’s pace the economy is achieving currently.

The IMF warned yesterday that the preponderance of fixed-rate mortgages that remain can still blow the economy off course again as borrowers seek out floating rate deals as the cost of renewing at a fixed rate becomes both prohibitive and unaffordable.

As household budgets are hit with the higher cost of floating rate loans. Even as the Bank of England lowers the base rate of interest, there is likely to be a significant “hit” to consumption. This will lead to a slowdown in demand, which will see the economy falter just as it is beginning to gain traction.

The pound suffered from the market’s expectation that yesterday’s inflation data in the U.S. would lead to the outcome that interest rates there won’t be cut until September at the earliest.

Sterling fell to a low of 1.2520 and closed at 1.2540 as it tested its medium-term resistance.

No one can say that the “writing was on the wall” Beginning at the most recent FOMC meeting, the minutes of which were published last evening and continuing through several speeches made by members of the Committee in the intervening period, there have been warnings that inflation was not falling as fast as the market was expecting/hoping and for this reason, the likelihood that the Fed would be able to fulfil the expectation of three or four rate cuts this year was in severe danger.

Since early March, the dollar has seen a steady improvement from its low of 102.35, but that progress was understated given the prospect of a continued pause in the level of interest rates.

Expectations have been managed from a cut being seen as likely in March at the turn of the year, as inflation fell following the pause in interest rate hikes, to June, in keeping with other G7 economies, then September.

Now, two Fed Presidents were being considered overly hawkish in commenting that the FOMC may struggle to make three cuts in rates this year and that only one cut may be possible and even then, in the fourth quarter.

Yesterday’s publication of inflation data for March saw the fall in prices “turned on its head”. Headline inflation rose to 3.5%, up from 3.2% in February and higher even than the market’s expectation of a rise to 3.4%.

All the comments from Powell, Kashkari, Bostic, and their colleagues were brought into sharp focus as the market was forced to reconsider monetary policy for the rest of the year.

Austan Goolsbee, the President of the Chicago Fed. was the “first cab off the rank” speaking yesterday in the wake of the data. He stated what may now be considered the obvious, saying that the Fed still has further to travel before it can claim victory over inflation.

The trade-off between driving inflation down and keeping employment high is coming to an end and will be ever more difficult to achieve going forward.

The data also provided more credence to fears that the economy may be coming close to stalling, although until the data confirms that, the market will continue to have faith in the Fed.

The dollar index rallied to a high of 105.30, its highest since November last year.

The comments from FOMC members before the next meeting will take on even more significance now, with comments about when the first cut will take place being treated more seriously by the market.

The dollar index closed at 105.19 and now looks set to continue its rally.

The market is expecting Christine Lagarde to set out a timetable for cuts in interest rates, the first of which is now considered almost certain to take place at the meeting of the Governing Council on June 6th.

However, she is unlikely to say how many cuts are likely to happen or the incremental size of each cut.

The popular view as G7 Central Banks have begun to consider rate cuts is that most will want to see one hundred points of cuts overall in four increments of twenty-five points each.

Although the Eurozone economy is the weakest in the G7, teetering on the brink of a recession, it is still unlikely that they will “front-load” the loosening of monetary policy by cutting by fifty points initially.

Members of the Governing Council have been ponderous in offering advance guidance on rate cuts even as inflation has fallen close to its target of 2%.

It was only when the most hawkish member of the Committee, spoke of the ECB preparing for a cut or cuts, that the market began to consider that they would begin in June.

There is still a wariness, which was highlighted yesterday, of what could happen to the Euro when the first cut takes place. The commission currency is now vulnerable and that could see a precipitous fall, which would change the entire outlook for inflation.

Although no one genuinely believed that the fall in inflation would be linear, that is what has happened and the market is now ill-prepared for any setback, which could easily happen if the ECB performs a “dovish pivot”.

Traders appear to have been lulled into believing that there was plenty of time to position themselves for the expected widening of the gap between U.S. and Eurozone interest rates, but the precipitous fall that the single currency experienced showed that the market was possibly even a little “long”.

For some that has been a chastening experience, and they may become a little more cautious since they won’t have had time yet to build a buffer against losses.

The euro fell to a low of 1.0728 and closed at 1.0742. A lot will be riding on the outcome of today’s meeting, with any comments that are considered overly dovish leading to further losses for the currency.

Have a great day!