15 January 2024: Chances of a cut in March growing week-by-week

The publication of GDP data for November as well as industrial production figures showed that a recession will have been avoided in the fourth quarter.

A contraction in the third quarter had led the market to believe that the economy would fall into recession when the data for the period between October and December was released. However, a contraction of 0.3% in October was followed by growth of 0.3% in November, leaving the outlook for the entire quarter in the balance.

While the fact that the economy is flatlining is no cause for celebration, avoiding a recession would be seen as a victory of sorts by the Government.

Preliminary PMI statistics for December have pointed to a pickup in activity in December, despite the storms that threatened to wreak havoc. Public sector activity is not part of PMI data, which may be a “saving grace” for Q4 GDP

The strikes that were called by junior doctors in December that have continued into the new year and led to 100k patient appointments being cancelled may see public sector activity dip again in the final month of 2023.

The news is brighter going forward, with speculation growing that inflation will fall close to the Bank of England’s 2% target as soon as March. This should allow short-term interest rates to be lowered from their eleven-year high of 5.25%.

Although Andrew Bailey has been cautious in expressing his confidence in inflation continuing to fall, he will face more pressure from Parliament to be more proactive in agreeing a cut in rates.

This week sees the release of pivotal data, with the December employment report due tomorrow, followed by inflation numbers on Wednesday.

The headline claimant count is not thought to have changed materially from the 16k new claimants that were seen in November, while wage increases will still be too high for the Central Bank’s liking, although they are likely to have fallen from 7.2% to 6.8%.

Until wage increases fall closer to the rate of inflation, the Bank of England will want to avoid the possibility of “stoking” inflation by cutting rates aggressively.

Headline inflation is believed to have fallen in December, bucking the trend in other G7 economies. A fall from 3.9% to 3.8% is expected, while core inflation also fell from 5.1% to 4.9%

The pound had a relatively quiet week, as the market is still considering which G7 Central Banks will be the first to cut rates. It stayed in a narrow range, rising to a high of 1.2785 and closing at 1.2744.

A rise in headline inflation to 3.4% in December was larger than the market had expected and with the first cut in interest rates considered to be on a “knife edge,” the data may influence the FOMC to hold off for another one or two meetings.

With economic activity well above the level which encourages thoughts of a recession being imminent and the level of new jobs being created remaining strong, the Fed still lacks any incentive to act in what could be a precipitous manner.

Neel Kashkari, the President of the Minneapolis Federal Reserve, believes that the FOMC has no need to be in a hurry to cut rates. Kashkari will lose his seat on the FOMC in 2024 due to the rotation of members but will still be an influential commentator on the economy.

He spoke last week of the emergence of the “Goldilocks” scenario for the economy but does not expect that to last more than a single quarter. As inflation continues to fall, and the number of jobs created begins to “rationalize,” the Fed may see a “window” to begin rate cuts.

One of the key reasons that the economy has been so strong relative to other G7 economies recently has been the significant strength of consumer spending.

Seventy percent of GDP is made up by consumer spending, so even a slight change can be significant.

January always provides a dose of reality for households as credit card bills that show spending over the Thanksgiving and Christmas holidays begin to arrive.

With more than one trillion dollars now outstanding on credit cards, consumers may well be forced to rein in spending for a few months.

December’s data for retail sales is due for release on Wednesday, and it may well be the last month that shows a month-on-month increase until the Spring.

Weekly jobless claims are also showing a slow but steady increase, which may be a precursor of a slight weakening of employment data.

For now, though, the market will begin to consider the outcome of the FOMC meeting which is due to take place in the first week of February.

Traders believe that the meeting will be something of a damp squib, but the Fed always retains a capacity to spring a surprise.

The dollar index remained in a narrow range last week, closing just two pips higher at 102.43.

Philip Lane, the ECB’s Chief Economist, and a member of its Executive Board, believes that the Central Bank may wait until it has first quarter wages data before it feels comfortable in cutting interest rates.

Employment in the twenty-country union has been surprisingly strong over the past eighteen months as interest rates have risen to record levels.

It has long been felt that the data is unreliable, but even with a large margin for error, new jobs have been plentiful as the free movement of labour is working as the European Commission hoped it would.

There may come a time when a shortage of jobs in the more established Western European Economies leads to a degree of social unrest, especially if Brussels fails to get to grips with migration, whether it be legal or illegal, and this may see the European Parliament lurch to the right when elections are held in early June.

Lane went on to say that cutting rates too soon may in the end be self-defeating, as it could lead to inflation re-igniting and rates needing to be hiked again.

With inflation under control and despite continued hawkish comments from members of the Governing Council, the market still feels that the first cut will take place in March or April.

That has been the interpretation of Christine Lagarde’s most recent comments.

Lane’s interview echoed comments made by hawkish German economist and Executive Board member, Isabel Schnabel last week, in which the said that until the ECB had confirmation of a continued fall in wage settlements, any rate cut will be premature.

She also said that since the first quarter wage data won’t be available until early June, she would like to see rates remain unchanged. It is understood that the first time a rate cut is scheduled to be discussed is at the April meeting.

A vote will be in the hands of the “moderates,” since the confirmed hawks and doves are unlikely to change their positions.

The euro is still struggling to make any headway above the 1.10 level. It reached a high of 1.1003 last week but was repelled and fell back to close at 1.0953.

Have a great day!