21 June 2024: The MPC leaves rates unchanged

The MPC, as expected, voted to leave the base rate unchanged at its meeting yesterday.

Bank of England Governor, Andrew Bailey, shared his thoughts about why interest rates remain elevated despite the economy again stumbling to see growth having flatlined again in April.

With inflation having fallen to reach the Bank’s 2% target last month, reporters were entitled to ask why, following the assurances given over the past few months that the Committee wouldn’t necessarily need to wait until it reached 2% before agreeing a cut, that it hadn’t acted yesterday.

In response, Bailey cited high continued high services inflation and that wage settlements are still significantly higher than the headline inflation rate.

Although the City expects a cut to be agreed upon at the September meeting, the prospect of a cut being agreed upon at the Committee’s next meeting, scheduled for August 1st, has grown significantly.

The vote was still 7-2 in favour of no change, the same as last month, but there is no information, other than the bare details of the result, to say how many members were close to changing their vote.

Bailey’s accompanying statement revealed differing opinions on inflation’s future, particularly in the services sector, which is central to the economy. “It’s good news that inflation has returned to our 2% target,” but wages are still lagging, adding inflationary pressure, particularly in the services sector.

Any change in the level of interest rates agreed upon at yesterday’s meeting will certainly have come too late to save Rishi Sunak and the Conservative Party from the crushing defeat that polls are predicting in the General Election, which is now less than two weeks ahead.

However, a cut, less than a month after Keir Starmer is installed in Downing Street will be a welcome development for Labour.

Following last evening’s leaders’ debate, Sunak faced another series of awkward questions, and yet again he had to apologise for yet another scandal.

Betting patterns in the days before the election announcement show that there was a raft of bets placed by people with insider knowledge. This will have cemented the Conservative’s reputation for sleaze and hammered the final nail in the coffin of any thoughts of a revival in their fortunes.

The pound fell to its lowest level in a month as the prospect of an August rate cut became clearer. It fell to a low of 1.2654 and closed at 1.2657.

No matter what economists throw at the U.S. economy and its potential to weaken during the second half of the year, it continues to produce numbers relating to the employment market which show that the Fed is correct to hold off on a cut in interest rates until job creation and jobless claims show that the level of interest rates has become a significant factor.

The weekly jobless claims data which was published yesterday shows that although claims have crept up in recent weeks, they are still close to their four-week average.

Reaching a ten-month high recently, claims gain abated marginally in the latest period. The four-week average, which smoothes out the weekly gyrations of the figures, rose to 232,750, its highest level since last September.

With unemployment still at 4%, historically, anything below 5% has been considered as “full employment”, the Fed can be fulfilling one part of its mandate.

Price stability needs further work, but the Central Bank’s primary tool is such a “blunt instrument” that even the idea that the FOMC is considering a rate hike would send paroxysms through the market.

This has been a week in which several Fed officials have expressed their views on the economy, interest rates and inflation.

Yesterday, Richmond Fed President, Thomas Barking said that he believes that the FOMC still has the firepower to address policy issues going forward but will have to maintain a strict data-dependency as policymakers look to time rate cuts appropriately.

Neel Kashkari, the President of the Minneapolis Fed, has become Jerome Powell’s apparent proxy recently since he doesn’t currently have a seat on the FOMC’s voting panel, so his comments are less likely to influence market sentiment.

Yesterday he spoke of his belief that wage growth is such that it will be difficult for inflation to reach 2% for up to two years. This is a similar sentiment to conclusions made by the more hawkish members of the ECB’s Governing Council recently.

Today will see the release of preliminary PMI data for June, with both services and manufacturing output likely to have moderated marginally, although both are still well into positive territory.

The dollar index has seen a positive reaction to Fed comments this week. Yesterday it rallied to a high of 105.67 and closed at that level.

Next week will see the publication of Q1 GDP data, which is expected to remain unchanged from its previous release, at 1.3%. Data for Personal Consumption Expenditures is also due for release, with inflation still struggling to fall below 2.8%.

The ECB may well be on the verge of instigating another financial crisis in the Eurozone by simply “doing its job” of policing Eurozone members’ debt-to-GDP ratios and budget deficits. Several members of the Union face disciplinary action, which amounts to little more than a “slap on the wrist,” despite the situation close to becoming out of control.

Under the old Growth and Stability Pact, budget deficits were to be held at 3% of GDP while debt-to-GDP rations were to be under 605.

The pandemic “blew that arrangement out of the water” with hardly any Eurozone members being compliant at the end of 2023.

The average ratio was 88.6%, although that was marginally lower than at the end of the third quarter.

However, budget deficits have ballooned post-pandemic. The average is now 3.6%.

The French election now looks like Marine Le Pen’s National Rally is to lose, with the Party having established a significant lead over Emmanuel Macron’s Renaissance Party.

A victory for the National Rally may pit two of Europe’s strongest female leaders against each other in Le Pen and ECB President Christine Lagarde. With the French debt-to-GDP ratio already at 110.6%, close to double the ECB guidance level, and its budget deficit nudging 5.5% and Le Pen promising an ambitious public spending budget if/when elected, the two are on a collision course.

It is expected that Lagarde may well stand for the Presidency of France when her term at the ECB, and that is almost certain to place her in direct opposition to Le Pen, with Europe at the centre of their differences.

Before that titanic struggle takes place, the ECB may have to intervene in the capital markets if the spread of French Government debt over Germany widens any further.

Yesterday, the European Union ratcheted up the pressure, placing France under formal ‘deficit’ measures. By the autumn, officials in Brussels will be demanding that Le Pen imposes tens of billions of spending cuts to bring the deficit under control.

If she refuses, as she certainly will, the bond market will be in turmoil, and the government may find it impossible to finance itself.

France may then face what the current Finance Minister called a “un moment de Liz Truss.”

The euro returned to its familiar path lower yesterday, falling to a low of 1.0701 and closing at 1.0702.

Next week, there is no tier-one data due for release in the Eurozone, so the single currency may return to its reactive phase driven by any further strength of the dollar.

Have a great day!