17 July 2024: Reeves urges the Bank of England to cut rates

The Chancellor of the Exchequer made her views on monetary policy perfectly clear yesterday in a speech in which she called for the Bank of England to cut the base rate of interest at its meeting two weeks from tomorrow.

She said homeowners with mortgages would welcome the Bank of England reducing its base rate, as it would provide “relief” for many suffering in the cost-of-living crisis.

Ultimately, Reeves controls the Bank of England and its monetary policy committee, given that the appointment of the Governor and independent members of the MPC is within her gift.

Since Gordon Brown, a Labour Chancellor, created the MPC to provide the Bank with a degree of independence, successive Chancellors have allowed that independence to flourish providing a non-political aspect to monetary policy.

Indeed, the Current Governor, Andrew Bailey, spoke in the run-up to the election about the need for the MPC to remain apolitical and not make decisions which could be construed in that light.

Contrary to Reeves’ comments, Huw Pill, The Bank’s Chief Economist, has expressed his opinion that a rate cut should be delayed given that there remains an “uncomfortable strength” in underlying inflation dynamics.

Given that the IMF reported yesterday that it believes the UK economy will be the strongest in Europe over the next year, the Bank may well find itself in a similar position to which the Fed found itself earlier in the year, where the economy is growing at a level which allows It the “luxury” of deciding in its own time when it will be appropriate to cut rates.

Although headline inflation fell to 2% in May and is expected to remain at that level when the data for June is published later this morning, core inflation which strips out the more volatile items like foodstuffs and energy is still expected to be at 3.5%.

In the latest employment report, due for release tomorrow, there is expected to be a welcome fall in average earnings to 5.7% from 6% last month. While this shows that wage increases are moving in the right direction, the MPC may want to see them fall closer to the inflation rate before a cut is agreed.

Independent MPP member Swati Dhingra also called for rates to be cut recently.

Catherine Mann, Megan Greene, and Jonathan Haskel are expected to vote for no change, although Dhingra is likely to be joined by Dave Ramsden who voted for a cut last time, while the rest of the permanent members will “toe the Party Line.”

No doubt sceptics will question Reeves’ motives, as the new Government continues its “growth at all costs” policy.

Monetary Policy is at the centre of currency movements as three major G7 Central Banks are considering cuts at upcoming meetings. For the Bank of England and Federal Reserve, it may be “one meeting too soon,” while the ECB may be considering the current political upheaval in France as a reason to delay for now.

Yesterday, the pound showed a little strength but was unable to match the level it reached at the end of last week. It reached a high of 1.2980 and closed at 1.2973.

Following his recent testimony to Congress on the state of the U.S. economy, Jerome Powell indulged in a little soul-searching yesterday as he spoke of being “wrong-footed” by the rise in inflation in the immediate aftermath of the Coronavirus Pandemic.

Without referring directly to his comments, he regrets his opinion, expressed at the time, that any rise in inflation was “transitory.” The size of support that was injected into the economy by the Biden administration had a far greater effect on demand than had been expected.

Outside influences over which Powell had no control played a significant role in inflation reaching a high of 9%.

However, he is proud of the part that has been played by the FOMC in bringing inflation down close to the target of 2%. Committing that if deflation remains on a firm path towards 2% the Committee will be comfortable in cutting rates imminently.

Given that the pace of deflation has slowed to a crawl, it will be a brave move to cut rates at the September meeting. There is no meeting scheduled between now and September 18th. This may well be seen as a positive since Committee members will be able to see two further inflation reports before deciding on a cut.

Fed Board Member, and voting member of the FOMC since last September, Adriana Kugler, spoke yesterday of her “cautious optimism” that a rate cut will be an “available option.” She based her comments on the view that the employment market is cooling “rapidly.”

Her FOMC colleagues, Thomas Barkin and Chris Waller, are both scheduled to speak later today.

Both Barkin and Waller have made slightly hawkish comments recently, with Barkin saying that the economy is “coping well” with the Fed’s battle to drive inflation lower, while Waller sees “no rush” to cut rates.

The dollar index lost more ground yesterday as the market continues to see a rate cut happening at the September FOMC meeting. A cut would “level the playing field,” between the U.S. and Eurozone since the ECB is unlikely to cut again tomorrow.

The index fell to a low of 104.20 and closed at 104.24.

The ECB finds itself in something of a dilemma. While the threat of stagflation has disappeared, the Eurozone is suffering from below-trend growth and a level of inflation that is a concern for the more hawkish members of the Central Bank’s Governing Council.

The rate cut which was agreed at the last meeting came as “payback” for the Council’s “doves” agreeing that rates could remain “higher for longer” when several economies were suffering and sliding into recession.

It may well be that all outstanding debts have been settled and the ECB can now genuinely be driven by the data.

News that the UK economy is expected to be the fastest growing economy in Europe this year will have “rubbed salt into the Brexit wounds” which are still causing pain in Brussels.

Ironically, the EU has lurched to the right in the past eighteen months, electing the first opening far-right Government in Italy since the war and coming perilously close to doing the same in France. It was only some high-level “horse-trading” which stopped that from happening.

The Government in London is openly seeking closer ties with Brussels, given that popular opinion is that the Brexit deal was poorly negotiated and just as inadequately delivered.

The EU Commission is now in a tough spot.

Economically, it would welcome closer ties to the UK with the greater trading opportunities they would bring, but it will need to be wary that other members may see benefit in “loosening Brussels’ apron strings.”

It is hard to see any significant economic progress made in the coming months without a series of rate cuts, despite inflation exceeding its 2% target.

However, the region is also in desperate need of systemic changes to both its constitution and its economy. A Fiscal Union has become a priority given the diluting effect legal changes to fiscal policy had on the tightening of monetary policy as inflation threatened to become out of control.

A unified defence policy is also vital to ensure that the U.S. supports the NATO budget.

Only four members of the EU, Cyprus, Malta, Austria, and Ireland are not members of NATO, so an agreement should not be difficult to achieve. The difficulties will come when there are disagreements over policy.

If Trump wins the Election in November, NATO may need to review its support for Ukraine.

The Euro is still driven by potential changes in monetary policy. Although it rallied to a high of 1.0905 yesterday, there is still significant interest to sell above 1.0920 which may cap any further advance, particularly since the market has already factored in a “no change” decision tomorrow.

The Euro eventually closed at 1.0899.

Have a great day!