15 May 2024: The BoE may be forced to delay

The April employment report published yesterday provided mixed signals to the Bank of England as it prepares to lower interest rates from a sixteen-year high.

The number of people claiming unemployment support rose to 8.9k from a downwardly revised fall of 2.1k in March. However, average earnings increased by 5.7. This was unchanged from the March figure, which was revised up from 5.6%.

Despite the disappointing wage data, the market expects wage inflation to cool in the coming months as jobs become harder to find, encouraging workers to accept lower salary increases.

Overall, the prospects of a rate cut have been pushed back, with September expected to see the MPC agree to lower rates as inflation falls closer to the Bank’s 2% target.

In a speech last evening, Huw Pill, the Bank’s Chief Economist, reiterated his recent remarks that the economy still has “some way to go” before a rate cut can be considered.

He confirmed that it is “not unreasonable” for the markets to expect a rate cut in late summer, but “saying it and making it happen are two very different scenarios”.

Members of the Monetary Policy Committee will look very carefully at the inflation and wage data in the run-up to their next meeting. Naturally, each member will interpret the data differently, guided by their view of how the economy has performed since rates have remained unchanged.

The news that the economy not only exited the recession that it had entered in the second half of 2023 but had done so in spectacular fashion has given the Bank a bit more wiggle room since it is no longer “staring down the barrel” of a long and damaging economic contraction.

Some of the increase in average earnings can be attributed to the increase in the minimum wage which came into force at the start of the new financial year, but the bank will want to see wage increases continue to moderate.

Pill’s comments back up last week’s observations from the Bank’s Governor, Andrew Bailey, in which he encouraged the market not to view a rate cut in the coming months as a “fait accompli.”

The pound rallied given the prospect of interest rates remaining unchanged over the next few months.

It climbed to a high of 1.2593 and closed close to that level.

Jerome Powell has become a little more hawkish on inflation as the year has progressed. He has sometimes been a lone voice in calling for the market to be patient due to the slowing rate of deflation.

Several market practitioners have tended to disregard his comments, possibly due to his lack of a background in economics. However, his pragmatic approach has seen several of his colleagues come around to his more simplistic approach, which has been driven almost entirely by economic developments.

Looking back to the start of the year, Powell never felt able to provide anything more than a “high probability” of a cut in interest rates at some point this year, but also said that a cut would be dependent upon inflation returning to the Fed’s 2% target and employment data moderating.

The headline rate of inflation must have stalled over the past three months. Several FOMC members have called for patience from the market during that time, needing more information before coming to a judgment.

It may well be that the economy has reached a “status quo”, in which economic output is moderating but at a far slower rate than was expected.

It has taken far longer for the number of new jobs being created monthly to begin to fall, and even now it is only one month’s data that is encouraging the market to believe that the slowdown has begun. It is well known that the monthly non-farm payroll numbers are notoriously volatile.

In a speech yesterday, Powell spoke of his concern that the rate of inflation may not be on a path to return to the Fed’s target.

“The first quarter in the United States was notable for its lack of further progress on inflation, and while we did not expect this to be a smooth road, the numbers have been higher than a median expectation.”

Powell often uses language more commonly seen in courtrooms than in the financial markets to get his point across.

This has often led to Market accusing him of being less concise about his views than is necessary.

The level of expectation about today’s publication of inflation data has been lowered by the Fed Chairman’s comments, which was probably his intention all along.

The dollar index retreated to a low of 104.96 and closed at 105 yesterday. The market is still confident that the U.S. economy is performing “adequately” given the current Fed Funds rate, and a rate cut will only take place when it shows more definite signs of faltering.

Productivity is still a significant factor in economies that are still driven by industrial and manufacturing output, rather than the new paradigm where services have become dominant.

This means that the Eurozone has two options available to it; the first is to increase productivity across the entire region to a level previously only seen in Germany or to embrace the fact that it is unable to compete with China.

This will be a painful decision for the region since it has failed to capitalize on what is effectively a “captive market” for its products.

This change in focus for the Eurozone will be especially difficult for it to achieve since its largest and still most dominant economy still is committed to energy-hungry heavy industry.

Until Germany accepts, in the same way as the U.S., that it is unable to compete with China in manufacturing output, its economy will suffer.

German manufactured goods have always been considered of a higher quality than those produced in Asia.

First, it was Japanese electronics that eclipsed Germany. Then it was vehicle production where Mercedes, BMW and Audi cars manufactured in Germany were perceived to have a level of quality and luxury that Toyota and Nissan couldn’t match even when they introduced luxury marques like Lexus and Infinity.

Now China is making significant strides but using a different business model. It is not interested, for now, in promoting Chinese brands, content with increasing market share in production using all the advantages it has at its disposal.

European car manufacturing is not “looking over its collective shoulder” yet at what became of the UK mass-produced vehicle market, but at some point, it may well be forced to do so.

There was yet another downgrade in expectations for German economic performance yesterday.

The German Council of Economic Experts downgraded its prediction for German growth in 2024 to 0.2%. It cited high energy costs, lacklustre global orders and the continued high level of interest rates as factors in its downgrade.

The Euro is still supported by the level of interest rates. The proposed cut may well see the German share of global trade increase as the Euro falls to a more “competitive” level.

Yesterday, the single currency rallied to a high of 1.0826 as it absorbed several large sell orders around the 1.08 level. It closed at 1.0820, but any strength may well be short-lived, as the ECB appears to still be committed to a cut in rates in June.

Have a great day!