16 February 2024: The pressure is now on the Bank of England

After months of speculation about when interest rates will be cut, the pressure for cuts to take place has been “ramped up” by the news that the UK economy has slipped into a recession.

There have now been three recessions in the past twenty-five years, The first followed the financial crisis in 2008 and was by far the most severe. The recession that took place in 2022 was precipitated by the first Covid lockdown when the country’s retail and services sectors simply closed down.

The economy has been “bumping along the bottom” for some time, and a recession can be caused by a slowdown in a single sector of the economy. That is what marks the current contraction apart.

The construction sector has been struggling for a considerable period. It was on the cusp of a significant slowdown for almost 2023, but the fourth quarter of the year saw borrowing costs and inflation take a toll on activity.

Although both the services and manufacturing sectors appeared to “weather the storm”, it was building projects which took the hit.

Jeremy Hunt was asked if he believes that the economy is in recession, and he replied that the “standard” definition has been reached. The Prime Minister has spoken of his feeling that a corner had been turned since the end of the year, so presumably he expects growth to return in the first quarter of this year.

Hunt is a firm believer in the independence of the Bank of England, and he went on to say that the recession has been caused by the focus of the Bank’s monetary policy decisions on bringing inflation down. It will now be a matter of time before the time is right and there is sufficient confidence in the fall in inflation for rate cuts to begin.

Politically, the fact that the country is in recession, no matter how mild it is likely to be, is bad news for the Government, which has seen Labour’s lead in the opinion polls eaten into by the latest row over deep-rooted anti-Semitism in the Party.

Rachel Reeves, the Shadow Chancellor, laid the blame for the contraction firmly at the door of the Prime Minister. She spoke of her view that the economy has stagnated since Rishi Sunak took office, and it was only a matter of time before it slipped into recession.

In the two earlier recessions, the economy slumped into recession quickly due to two specific events. The current recession has been coming for the past year and can be characterized as a dip, rather than a slump since the remedy is likely to be administered in the next few months.

One likely outcome of the news is that any thought of an election being called has been put on the back burner.

The pound made ground against the dollar yesterday as the market reacted with a sense of inevitability to the news and the belief that the recession will be short-lived.

Sterling climbed to a high of 1.2600 and closed at 1.2596.

The doom-mongers have been searching the good news that has been published regularly over the past two quarters for signs that the economy will soon perform a significant U-turn and begin a slowdown which will lead to a recession.

They have tried to find a reason to say that interest rates must be cut, but with equity markets close to an all-time high and the economy creating jobs at an above-average rate, they are having little success.

The size of the fiscal deficit has become a “stick with which to beat” the Biden Administration, but Treasury Secretary Janet Yellen, herself a former Chair of the Federal Reserve, believes that it is “sustainable”. Jerome Powell may have other ideas, but he reserves his judgement to be made in private.

Most people’s choice to eventually replace Powell as Chairman of the Federal Reserve, former vice-chair, Lael Brainard has been out of the spotlight recently as she performs her duties as Director of the National Economic Council, advising the President on U.S. and global economic policy.

She spoke yesterday of her belief that the economy is significantly stronger than it was a year ago and is now stronger than it was at the same stage of previous recoveries. Inflation is on target to reach the Fed’s 2% target, while unemployment still is at historical lows.

There are still bottlenecks, particularly in the housing sector, where rental rates are still “too high”, but Brainard believes that the few” kinks” will be ironed out over time.

The FOMC’s favoured measure of inflation, Personal Consumption Expenditures, has been around 2% for the past six months. While this includes different metrics for consumer prices, the trend is for inflation in general to fall.

With both the UK and Japan falling into recession, Brainard is still confident that the U.S. won’t suffer a similar fate.

The dollar index retreated from its recent highs yesterday as it ran into significant profit-taking from short-term traders. The trend remains upward and is likely to return as new drivers come to the fore.

The Greenback fell to a low of 104.18 yesterday and closed at 104.26.

Similarly to the UK, Eurozone GDP has been “bumping along the bottom” for several quarters and has been struggling for growth as it emerges from the clutches of the Pandemic. There have been some bright spots recently as Spain, Portugal and some Baltic States saw growth, but that has been overshadowed by a significant fall in output from Germany, Ireland and the Netherlands.

Overall, the Eurozone economy has been stagnating for the past year, exhibiting zero GDP growth. It is running the risk of falling into a comparable situation to the UK, but there does seem to be a growing feeling that the bottom has now been reached.

The Eurozone has some systemic issues that will need to be addressed, but the ECB has been looking to the European Commission for support and not receiving any.

There have been a growing number of Central Bank Governors from “less influential” Eurozone members who have felt able to make their views about a cut in interest rates known.

Yesterday, the Governor of the Central Bank of Malta spoke of his openness to a rate cut as inflation is falling rapidly, which has placed the region on course for a soft landing. There may well be a soft landing, but the approach has been anything but smooth.

The Eurozone began 2024 on a far weaker footing than had been expected.

This is likely to precipitate another year of subdued growth. Most economists believe that the remedy to the malaise is simple. A series of rate cuts beginning no later than the April Governing Council Meeting would provide the necessary spark.

Christine Lagarde, already under pressure from criticism of her performance as a leader, will be wary of being forced to admit that the ECB over-tightened before leaving rates unchanged.

There was a genuine feeling that rate hikes would be ended at the first meeting after the extended August break, But the Governing Council voted for a further hike before pausing.

The most recent hikes are still working their way into the Eurozone economy since their effect has been “watered-down by changes in fiscal policy across the region.

The euro continues to be supported by the general hawkishness of the ECB. Yesterday, the single currency rallied to a high of 1.0784 and closed at 1.0771.

Have a great day!