14 March 2024: Could the MPC cut rates next week?

Since the Bank of England paused its cycle of interest rate hikes last September, there have been several schools of thought about when rates would begin to be cut.

The more hawkish commentators, sided with MPC member Catherine Mann, sharing the view that prices would continue to rise for some time since there is a lag before the full effect of rate hikes “works its way into the economy”.

They were correct in their assumption that wage rises would soon exceed the headline rate of inflation, which would slow the fall. The hawks felt that it might be necessary for a further hike to quash inflation, but that has not been the case.

Although Mann voted for a hike on February 1st, she has since confirmed that she was undecided if another hike is now called for and will likely vote for no chance at the next MPC meeting.

Andrew Bailey has been reluctant to provide any clues about the future path for short-term interest rates, preferring to “keep his powder dry” in case of a sudden surge in prices due to the developing political situation.

It was clear that there would be a period when rates would remain unchanged, since the majority of the MPC agreed that it would take time for the fourteen increases that took place between December 2021 and September 2023 and took rates from 0.1% to a fifteen-year high of 5.25% would take time for their full effect to be felt.

In the intervening period, the more dovish members of the MPC, led by Swati Dhingra wanted rates to be cut at once because she was concerned that the level of rates would drive the economy into a recession that was far “worse” than the Bank intended.

Almost six months after the last increase, the time may have arrived for a cut to happen. Andrew Bailey confirmed recently that inflation did not have to have reached the Bank’s 2% target for cuts to begin if there was evidence that it was making consistent progress.

Now, there are signs in the economic data that the level of interest rates is having an effect. This week’s release of employment data showed that jobless numbers are beginning to climb, as the number of new jobs is rising while the number of vacancies is falling.

It may be “too soon” for the MPC to vote for a cut next week since they remain cautious about inflation, but it would be a surprise if Andrew Bailey does not continue his more dovish approach, hinting at a cut at the meeting on 9th May, particularly since an Updated monetary policy report is due at that meeting.

The economy returned to growth in January, although it will need further positive results for February and March for the recession to be declared as “officially” over.

Yesterday, the pound steadied after two sessions of falls. If made marginal progress, reaching 1.2811 and closing and 1.2797.

There is a growing feeling that the Fed may be correct in delaying a rate cut until the end of the second quarter, as it wants to ensure that inflation is solidly on a downward path.

A recent survey of corporate CFOs showed that the majority have turned dovish over future Fed action, although they agree that the pause in rate hikes was correct, the time for cuts to begin is fast approaching.

There is a difference of opinion over the parts of the economy that are causing concern, with the survey believing that growth and activity have surpassed rising inflation as the area that should now be targeted, while the Fed is searching for certainty.

The recent publication of the February employment report still shows that job creation has not been affected yet by the level of interest rates, although some concerns are growing that there may be some “anomalies” in the data that are slowly becoming known.

Although the Conference Board index of leading indicators has recently moved away from predicting that the economy would suffer a recession this year, there are still two measures that are considered “red flags”. The first is the continued inversion of the longer-term yield curve, which shows it is more expensive to borrow for two years than ten.

In the post-war period, there have been very few occasions where such an inversion hasn’t led to a recession.

The second warning sign is the ISM new orders index, which forms part of the overall activity data that is produced monthly. New orders have been falling steadily since last September, possibly due to the level of interest rates on demand.

Economists at the Fed are using extensive modelling to produce recommendations for the FOMC, and their view has become a little more “dovish” recently, leading the market to consider a rate cut as “imminent.”

Today will see the release of retail sales numbers for February. The data is expected to see a rebound from January’s fall of 0.6% to 0.8% increase last month. Despite record-high household debt, the consumer has held up well during the period since last September.

The dollar index saw some weak longs exit positions yesterday, as the market saw no trend to encourage further buying. It fell to a low of 102.66 but was attracted back to its support level of 102.82, where it closed.

The ECB’s contention that it needs to concentrate totally on bringing inflation down to its target level of 2% before it can consider cutting interest rates is looking more and more like “tunnel vision”.

It looks like the period of rate pauses that G7 Central Banks have undertaken since around the end of the third quarter of last year, has worked its way into their mainstream economies to a greater or lesser degree.

The continued hawkishness of the ECB is being challenged by the level of economic activity that has fallen consistently since the turn of the year.

Data published yesterday showed that in January, economic activity in the Eurozone as a whole plunged by 6.7% after a rise of just 0.2% in December.

This was significantly worse than the market’s expectation of a 2.9% fall.

This is possibly the clearest indication yet that the rate hikes that ended last year are having a significant effect on demand.

It has already been noted that export demand has fallen considerably as the region lags behind both China and the U.S. in terms of productivity, now it seems that domestic demand is on a similar path.

The most notable fall was seen by Ireland, which saw a 29% fall in industrial production month-on-month. No immediate reason for such a precipitous fall was immediately available but given the transfer pricing irregularities due to the number of international companies that are based there, the data is often volatile.

The production of “big ticket” capital goods was the biggest fall at 14.5%, while both durable and non-durable consumer products saw far smaller falls.

Output rose marginally in Germany and Spain and fell in Spain.

In all, only eight of the twenty Eurozone nations experienced an increase in output.

At some point, there will need to be less notice taken of individual nation data as the Eurozone becomes more of a “Federal” body.

Free movement is still not having the smoothing effect that it was hoped to have since the creation of the European Union.

Isabel Schnabel, the most hawkish member of the ECB’s Executive Board, is making a speech later today. While she is unlikely to have switched her allegiance to “team dovish” the market will be looking for clues as to whether she will support a rate cut at forthcoming ECB meetings.

The Euro is still being supported by the perceived hawkishness of the ECB and will most likely remain supported until there is a definitive answer to the question of rate cuts.

Yesterday it climbed to a high of 1.0963 and closed at 1.0947.

Have a great day!