17 October 2024: Energy prices push inflation below the BoE target

Andrew Bailey has suffered from both perception and by comparison with his predecessor during his time as Governor of the Bank of England, He lacks the flamboyance of other G7 Central Bank Governors but has managed to achieve his goal with a minimum of fuss.

He has been criticized for not being sufficiently proactive in raising interest rates in greater increments when inflation threatened to become out of control in the period immediately following the pandemic. Still, he and his colleagues have now been the first to react twice, first by hiking rates in December 2020 and then, more recently, by loosening policy.

The Monetary Policy Committee over which Bailey presides is made up of several strong personalities who have very definite views on the economy, and it has been noticeable how the committee takes a wider view of the effect of their actions.

The permanent members of the Committee have historically taken their lead from the Governor. Still, the current “team” are not afraid to “plough their own furrow” as was seen recently when Huw Pill, the Bank’s Chief Economist, voted against the recent rate cut.

Of the Independent members, Swati Dhingra and Catherine Mann have vastly different views and occupy opposite points on the monetary policy “compass.”

Bailey and his team deserve huge praise for engineering a fall in inflation from a high of 11.1% to the level which was reported yesterday of 1.7%, even if they have had some help along the way.

The market would do well to ignore for now the fact that since there is a review of the energy price cap taking place imminently, which will undoubtedly see inflation return to a level just above the Bank’s target and allow Bailey a moment to “bathe” a well-deserved moment of success.

The fall in inflation to its lowest level in almost four years has been achieved due to some judicious decision-making and a not insignificant amount of luck. Nonetheless, coping with the difficult and sometimes downright bizarre actions of the previous Government has been a feat in itself.

Once he has allowed himself a moment of triumph, Bailey will need to cope with arguably the most important and probably most controversial budget in almost fifteen years.

Rachel Reeves has raised the size of the black hole in the country’s finances to close to forty billion pounds, and her efforts to plug that game will bring balancing fiscal and monetary policy into sharp relief.

Bailey’s most immediate task will be to preside over the next meeting of the MPC, which takes place on November 7th, during a week which is shaping up to be significant on both sides of The Atlantic.

Yesterday, the pound lost ground following the release of the inflation data. It fell to a ten-week low of 1.2977 and closed at 1.2990.

If Donald Trump wins the Presidential Election on November 5th, he will usher in a new period of volatility for the global economy as he makes good on his promise to add tariffs to a wide range of manufactured goods imported into the U.S.

The tariffs will range from 30% on some items to 200% on vehicle imports.

In an interview earlier this week, Trump intimated that “tariff” is his favourite word. His plans may be secretly supported by manufacturers, but consumers face significantly higher prices on everyday items, while the Fed will have to contend with the inflationary effect of Trump’s plans.

In an interview with Bloomberg three weeks before the election, the former president eschewed traditional economic thinking, complained about US allies Mexico and France, and made clear he is even more hawkish on trade than he was in his first term.

Trump called tariffs “the most beautiful word in the dictionary,” launching into a broad defence of his protectionist policies.

In an interview that at times sounded like it was out of his trade-focused 2016 campaign, Trump complained that the US is being taken advantage of by China, Mexico, and France. “All you have to do is build your plant in the United States, and you’ll have no tariffs.”

Trump said he would not allow US Steel to be bought by Nippon Steel, citing national security concerns, prompting shares to fall.

He is unimpressed by the growth of IT giants. He complained that Google is rigged “just like our government is rigged,” while on TikTok, he said he still views the Chinese-owned social media site as a threat despite changing his opinion on banning it from the US.

Although some of his comments appear to be more than a little paranoid, his points about national security resonate with some of the hawks in the Pentagon.

With less than a month to go before the U.S. elections, the American economy is in arguably the best shape it has been before any presidential contest in recent history. Unemployment is at a more than two-decade low. Petrol prices are not as high as they may seem, while even inflation looks better.

The recovery may have come too late for Kamala Harris. Feelings of economic euphoria take time to sink in.

It takes time for people to recognize the improvement in their situation after a period of economic volatility. That may explain why Harris still trails Trump in most polls on economic issues, as consumer confidence remains low. And she cannot change the fact that people feel less rich. Leading indicators such as consumer confidence remain low. And she cannot change the fact that people feel less rich.

Raphael Bostic, the President of the Atlanta Fed struck a more hawkish pose regarding rate cuts in a speech this week, he believes that a single rate cut of twenty-five basis points is all that is called for until inflation is confirmed as having fallen below the Fed’s 2% target.

The dollar index continues to make relatively small daily gains, which will cement its recent rally. Yesterday, it climbed to a high of 103.61 and closed at 103.52.

It is likely to enter the final weeks before the election in a bullish mode, but a period of volatility can be expected during election week when the October employment report will be published and the FOMC meet as well as an undoubtedly rumbustious election.

The next chapter in the global monastery policy saga opens later today, with the ECB expected to cut interest rates as inflation continues to tumble in the Eurozone.

Christine Lagarde and her colleagues who make up the Bank’s Governing Council are being driven by inflation data that has been as much a surprise to them as it has to many market participants.

It is now clear that members of both the Executive Committee and the Governing Council were unnecessarily hawkish in the views of inflation, which they felt would not sustainably fall below the 2% target until the end of next year.

While there has been no “Mea culpa” regarding inflation, the Governing Council has cast off its hawkish cloak and is now in full-scale growth mode.

There will be barely a whimper of dissent as rates are cut again today, probably by twenty-five basis points, although it will come as little surprise to some more dovish economists if a jumbo cut of fifty points is agreed.

Philip Lane, the ECB’s Chief Economist said in an interview recently that should the economic outlook “darken” then the Council will need to step up rate cuts.

When one considers that today’s expected cut will be a significant departure from the one-cut-a-quarter policy that was expected, it follows that a jumbo cut may gain a degree of favour.

The official account of September’s meeting, which was published last week, reveals growing concerns about the feeble state of the bloc’s economy.

Policymakers were also fretting that their forecasts might be too rosy, but Lane also stressed that, should inflation prove resilient, or there are signs of a stronger recovery, “a slower pace of rate adjustment could be warranted.”

Inflation is markedly dropping in Europe, even if the core trails behind. Plummeting energy costs have played a key role in reining in prices. Yet, the ongoing Middle East crisis could derail this process.

Later this year, unfolding tax rebates to relieve consumers badly hit by the inflationary bout will feed fresh pressures. Thus, unless the ECB resolutely cuts rates at this meeting, it may face mounting difficulties in scaling back its current restrictive stance. Lagarde now has a narrow window before potential headwinds trim her room of manoeuvre.

It is not yet a case of now or never and there is “plenty of water to flow under the bridge” before the next meeting, but it is as close to certain that it can be that Lagarde, and her colleagues will continue the ball rolling today.

The Euro lost more ground to the dollar yesterday. It fell to a low of 1.0853 and closed at 1.0862. The next downside target is at 1.0780, and with monetary policy seemingly on the verge of diverging further, it may not be too long until that is tested.

Have a great day!