12 September 2023: Mann believes the MPC should err on the side of over-tightening

Catherine Mann is far and away the most hawkish member of the Monetary Policy Committee. She spoke yesterday of her view that interest rates should continue to rise if inflation remains above the Government’s 2% target.

She went on to say that in her opinion, it would be better in the long run if the Bank erred on the side of over-tightening rather than bring the cycle of hikes to an end only to be forced to begin again should inflation flare up again over the winter.

Mann accepted that her opinion may be wrong but if the Bank had continued to raise rates and inflation decelerates at a faster rate than she expected she wouldn’t hesitate to introduce rate cuts sooner than expected.

While her views are considered radical, she is showing the kind of proactivity that has been found wanting during Andrew Bailey’s term as Governor.

Of the nine members of the MPC, five are permanent, the Governor, the deputy Governors responsible for monetary policy, financial stability, markets and banking, and the Chief Economist.

There are four independent members who serve a fixed term. There is a concern among MPs and within the financial community that the balance of the committee is wrong since it doesn’t encourage original thoughts, other than through comments that are made publicly, safe in the knowledge that they will never be implemented.

Mann’s colleague on the MPC, Swati Dhingra, holds an entirely opposite view. In her testimony before the House of Commons Treasury Select Committee recently, she informed MPs that she believes that interest rates are already sufficiently restrictive on demand and any further hike would carry an inherent risk.

Records show that since rates began to be increased, and probably for far longer before that the five permanent members voted as a bloc, which many believe makes the independent members’ roles redundant.

Rishi Sunak has publicly supported the makeup of the MPC since he was Chancellor, but facing pressure from back bench MPs over a range of issues he may feel that announcing a review of the MPC may gain him some credit ahead of what is bound to be a difficult period politically in the run-up to the General Election.

Sunk is facing a difficult situation since an aide to Parliament has been accused of spying for China. While he has held meetings with the Chinese Delegation to the G20 meeting that is going on currently in India, he is being encouraged to be more forceful in his condemnation.

On the other hand, the UK and China have a significant trading relationship that Sunak will want to preserve.

The pound rallied to a high of 1.2514 yesterday, as the market had become significantly “oversold”. It closed at 1.2510 and a lot will depend on the data releases on both sides of the Atlantic to decide its short-term path.

Wall Street is confident that the economy won’t fall into recession in the short to medium term given that it expects the Fed to announce a pause in the cycle of rate hikes that have been happening for over a year or change tack immediately and announce the end of the programme immediately.

However, further out, particularly considering the run-up to the Presidential Election that is scheduled to take place next November, there is considerable uncertainty.

Considering the signals that continue to point towards a significant downturn, the financial community continues to hedge its bets in attaching a low probability of the economy falling into recession, but it still sees a possibility.

Treasury Secretary, Janet Yellen, spoke yesterday of her confidence that a soft landing can be achieved while several Democrat members of Congress believe in the “Goldilocks Scenario”.

Yellen believes that the FOMC will be able to contain inflation without doing significant damage to the jobs market. That has certainly been the case with the net figure of new jobs created balancing off the increase in jobless claims.

There is little doubt that the FOMC’s programme of rate increases has coincided or possibly caused a rebalancing of employment.

She went on to express her confidence in the FOMC commenting that every measure of inflation is “on the road down”. The rise in unemployment in August was moderate following the lowest rate in fifty years and wasn’t created by wholesale lay-offs that would be synonymous with an approaching recession.

There is now close to 100% agreement that the FOMC will announce another pause in the cycle of rate hikes when it meets in a little over two weeks’ time.

Even Jerome Powell who has maintained his hawkish tendencies as inflation has fallen believes that a pause at this time will go some way to ushering in a soft landing.

The inflation report that is due for release tomorrow is expected to see a moderate rise but since that can be attributed to a single factor, gasoline prices, the FOMC shouldn’t be unduly perturbed.

The Dollar Index took some time out from its recent rise as a minor correction set in. It fell to a low of 104.41 and closed at 104.58 as the market positioned itself for tomorrow’s data.

Over the time since the last meeting of the ECB’s rate setting Governing Council, there have been numerous polls conducted asking just about anyone who is prepared to offer an opinion, their view on the outcome of the vote which will take place on Thursday.

A further poll was released yesterday which must be the last or very close to it, in which bank economists were found to favour a hawkish pause, in which ECB President Christine Lagarde announces a pause but also makes a statement in which he reserves the right to announce further hikes in the (near) future.

The alternative scenario is that there is another twenty-five-basis point hike with little or no announcement regarding future actions.

It may be that if there is a hike and inflation continue to be “stubborn” the ECB may find itself in a situation where there is no pause, and it goes straight from rate hikes to rate cuts.

There is a high degree of expectation that at least half the Eurozone nations will find themselves in a recession or on the verge of one by the end of the year.

Société Générale, the major French Bank, announced yesterday that it expects a hawkish pause, with the next hike taking place in December. It is doubtful that the Hawks from Austria and Latvia will be able to countenance waiting that long if they see inflation failing to be brought under control.

Lagarde is expected to note that the downside risks to the economy have increased since the July meeting. The Central Bank will retain its hawkish bias unless inflation has made significant progress towards its 2% target.

Once the ECB has announced the end of the cycle of rate hikes it will continue to tighten monetary policy by reducing the size of its balance sheet by entering what has become known as quantitative tightening.

The euro can expect to experience further downward pressure as it loses its rate “crutch”. For the rest of this week, the market will be positioning itself for the data and the fallout from the rate decision.

Yesterday the euro gained from the market’s reluctance to hold a long dollar position into the U.S. inflation report. It reached a high of 1.0759, closing at 1.0750.

Have a great day!