Highlights
- Reeves set to change the rules over long-term debt
- Jobs data crushes hope for another fifty-point rate cut
- ECB member Kazaks makes the “clear-cut” case for another rate cut
Analysts fear the effect of the Budget on monetary policy
However, the Bank’s Chief Economist, Huw Pill, has cautioned against cutting rates “too far or too fast”. Pill believes that there should be a gradual loosening of monetary policy to ensure that inflation is still at or close to the Bank’s 2% target.
Pill, who sits on the Bank’s nine-member interest rate setting committee chaired by Bailey, said: “While further cuts in Bank rate remain in prospect should the economic and inflation outlook evolve broadly as expected, it will be important to guard against the risk of cutting rates either too far or too fast.”
He added, “For me, the need for such caution points to a gradual withdrawal of monetary policy restriction.”
The recent cost of living crisis was a tough reminder of the economic difficulties inflation creates, especially for the less well-off and small and medium-sized enterprises, already vulnerable segments of the economy, which struggle to protect themselves from higher prices.
Pill prioritised structural economic changes after the COVID-19 pandemic and the Ukraine war.
The increase in the number of people leaving the labour market because of ill health has alarmed many policymakers, who are concerned it will force employers to bid up wages as they compete for a smaller pool of skilled workers.
As Rachel Reeves moves ever closer to delivering her first Budget, there are several different “lines of enquiry” about the changes she will announce. Investors are concerned about changes to capital gains tax, which is already affecting the level of fresh investment, particularly in start-up businesses.
Reeves is barrelling toward a career-defining fiscal statement on Oct. 30 facing a broad and sharp decline in sentiment among consumers and businesses, which economists widely attribute to fears about her plans to fill a £22 billion ($29 billion) fiscal hole.
While the left-leaning Labour Party’s first budget in 15 years was bound to have lasting consequences, Reeves’s doom-laden comments have made it a moment of short-term risk, as well.
Reeves has said that she wants to balance the country’s “day-to-day” costs within five years. The market fears that her plans may be too rigid since she won’t have any flexibility to react to any crises which will surely occur.
The pound lost a significant amount of ground following Bailey’s comment last week that interest rate cuts could become “more aggressive”. While Pill’s speech levelled the playing field somewhat, overall sentiment is favouring a lower outcome, particularly in light of the positive U.S. employment report.
Sterling fell to a low of 1.3069 and closed at 1.3116 last week, and to 1.1855 versus the Euro, although it rallied to close at 1.1955.
The data allows the Fed more breathing space
Two hundred and fifty-four thousand new jobs were created in September, significantly more than had been anticipated.
Fed Chair, Jerome Powell, said recently that if the FOMC had had access to the July figures at its July meeting the outcome, where they left rates on hold, would have been different.
Some semblance of balance has been restored since if they had known how strong the September data was, it is doubtful that they would have agreed to a fifty-point cut last month.
The Goldilocks scenario for the U.S. economy appears to be the “gift that keeps on giving” Inflation is at or close to the Fed’s 2% target while the economy is producing jobs data that is almost unbelievable given the Fed Funds rate that is still at 5% even following a jumbo rate cut.
It is safe to say that the economy has achieved a soft landing, although Powell will likely retain his reticence going forward.
The non-farm payrolls report released just a month before Election Day showed that the jobless rate fell to 4.1 per cent, while hourly wages grew at an annual pace of 4 per cent.
While this far exceeded expectations, it is in keeping with a soft landing, where the economy avoids a recession, which everyone especially Vice President Kamala Harris had hoped the Federal Reserve could achieve after it undertook one of the most aggressive series of rate hikes in its history in 2022 and 2023.
The Federal Reserve is likely to downsize its rate cuts to 25 basis points at both the November and December policy meetings, although the risk has now shifted towards only one cut over the rest of the year.
In typical fashion, almost as soon as the numbers were released, there was speculation about the next set even though the FOMC won’t have access to them since the next meeting is planned for November 6/7.
Since the Committee has altered its bias from inflation to job creation, it would be the sensible option to agree on either a twenty-five-point cut in November or to await the October employment report and cut by fifty points in December if necessary.
The dollar index reacted positively to the employment report, rallying to a high of 102.69 and closing at 102.49.
Later today, Bowman, Kashkari, Bostic, and Musalem will speak, and they may provide more context to the FOMC’s intentions.
The minutes of the most recent FOMC meeting are due for release on Wednesday evening, and the latest inflation figures are due to be published on Thursday.
A rate cut next week is still very much “on the cards”
Macron spoke last week of his view that the region should be considering a more protectionist agenda to safeguard the Eurozone’s most precious resource, the access to its population, while Scholz believes that Germany’s historical export markets would be damaged if it was a party to import controls or tariffs.
At an event in Berlin this week, the French president warned that the EU “could die” and that if it continues with a “classical” free-trade agenda, it will be “out of the market” in two or three years. He made the case that Europe should embrace a more protectionist agenda if it wants to survive.
Scholz meanwhile argued that a push to protect European industries from unfair trade practices “must not lead to us harming ourselves.” Germany is set to vote against new EU duties on Chinese electric vehicles on Friday after Scholz intervened to toughen up his country’s opposition to the move.
The clash dramatizes the dilemma facing the bloc’s 27 governments at a highly sensitive moment for global trade. The U.S. presidential election is on a knife edge and could see Donald Trump re-elected in a month.
He has past form for playing hardball with the EU on trade and has proposed sweeping new tariffs if he wins back the White House for the Republicans.
Germany’s economy ministry plans to downgrade its 2024 economic growth forecast, expecting Europe’s largest economy to shrink by 0.2%, its newspapers reported on Sunday.
The forecast for an inflation-adjusted contraction, which the ministry is due to publish on Wednesday, follows an earlier government projection of 0.3% growth this year after a 0.3% contraction in 2023.
Last month, Germany’s leading economic institutes downgraded their forecast for 2024 to a contraction of 0.1%.
German Media also reported yesterday, that the Ministry for the Economy, led by Robert Habeck of the Green party, also plans to issue a forecast for 2025 economic growth of 1.1%, up from the 1% forecast previously, and for 1.6% growth in 2026, banking on a package of government measures to stimulate growth.
Europe needs bigger and stronger banks that can compete with their US and Chinese rivals, European Central Bank President Christine Lagarde said on Monday, just as Italy’s UniCredit was looking to possibly take over Germany’s Commerzbank.
UniCredit, Italy’s number two bank, is pressing for a tie-up between the lenders after snapping up a Commerzbank stake earlier this month, drawing criticism from both the bank and Germany’s political establishment, who want to keep the lender independent.
The Euro has ended its period of strength that endured across the entire summer. It fell through the psychologically important 1.10 versus the euro that has provided support since mid-August.
It fell to a low of 1.0951 following the positive U.S. employment report and closed at 1.0971.
Eurozone retail sales data is due for release later this morning, and the German inflation report for September will be published on Friday.
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04 Oct - 07 Oct 2024
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Alan Hill
Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.
