21 February 2024: Bailey is bullish about a recovery

Bank of England Governor, Andrew Bailey, gave an unusually bullish assessment of the prospects for a recovery in the UK economy yesterday. Bailey considers that the cumulative contraction of the economy by 0.5% is by far the “mildest” recession that the UK has seen in the past fifty years.

In earlier recessions, the minimum contraction has been 2.5%.

He was joined by MPC colleague, Ben Broadbent, in giving testimony to the Parliamentary Treasury Select Committee. Broadbent went on to say that, although two quarters of negative growth is the “standard” definition of a recession, different countries, including the U.S. define a recession in different ways.

Bailey was also surprisingly dovish about a cut in interest rates. He said that the Bank could begin to cut rates before the rate of inflation falls to the Treasury’s target of 2% if the progress that has been made so far on service sector inflation and the labour market continues.

“Wages are adjusting downwards, contributing to lower inflation overall, which is encouraging.”

Bailey emphasized that sustained progress in bringing wage demand in line with inflation is a “better metric” for cutting interest rates than the “quantitative absolute” of the rate of inflation reaching 2%.

Swati Dhingra, one of the independent members of the MPC and a renowned dove, having voted for the rate to be cut ever since the series of hikes ended, told MPs that in her opinion, if interest rates remained “higher for longer” it could damage some parts of the economy.

“Despite disinflation being “in play” and even though there has been some real recovery in wages, we are still seeing very weak consumption and very different from some of the other advanced economies where there has been a rebound from pre-pandemic levels”, according to Dhingra.

Overall, this amounted to a far more dovish session than was expected given the outcome of the most recent Monetary Policy Committee meeting.

A cut in interest rates at the next meeting of the MPC is still unlikely since Bailey and his colleagues want to see further progress on inflation, but a cut at the May meeting is now considered probable.

The pound rose to a high of 1.2668 versus the dollar as the prospects for the economy were seen in a more positive light. It closed at 1.2624, close to the top of its recent range.

The case that has been made recently that the U.S. economy is heading for a recession received a blow yesterday, as the index of leading indicators is no longer predicting a contraction.

The Conference Board abandoned its long-running call for the economy to fall into a recession, although it still sees growth flatlining in the coming months.

The business research group’s index, meant to be a gauge of future economic activity, fell 0.4% in January to 102.7, the lowest level since April 2020 when the U.S. was in a brief recession after the onset of the COVID-19 pandemic and related shutdowns.

This was the twenty-third consecutive fall, just one month short of the record. However, the six-month moving average has slowed sharply, and its rate of decline is the slowest since the summer of 2022.

While a decline in the leading indicator index (LEI) is synonymous with a lowering of economic expectations, six of the ten constituent parts are now in positive territory. As a result of this, in the conference boards’ opinion, the U.S. economy is no longer facing a recession this year.

One of the main positives noted by the conference board was the performance of stock markets. A 20% rise in the level of the S&P 500 since October shows the markets’ confidence in the economy’s strength.

The minutes of the latest meeting of the FOMC are due to be published later. Given that the outcome of the meeting was entirely as predicted, there is no reason for the minutes to hold any “surprises” for traders.

There will still be those who thoroughly digest them, in the hope of finding a clue to the FOMC’s future intentions.

The dollar index retreated to its lowest level this month as traders took profits on stale long positions. It fell to a low of 103.79 but recovered to close at 104.06.

Purchasing Managers Indexes are due for release tomorrow, with expectations that both the index of service activity and the composite index will see mild falls in the markets “base case.

Given the continuing contrast between the hawkish outlook of the ECB’s Governing Council and the monetary policy comments from the Governor of the Bank of England, the single currency may be in for a period of sustained growth against the pound.

So far this year, the pound has seen a sustained rally from a low of 1.1444, although this may be about to change. Although the Eurozone’s largest economy, Germany is facing a recession, the rest of the region is beginning to show signs of a recovery from its post-pandemic depression.

Several Eurozone economies have countered the worst of the effects of rising interest rates by loosening fiscal policy to compensate.

Italy has been the most obvious “culprit” introducing several initiatives that flout the growth and stability pact which calls for budget deficits below 3% and a debt-to-GDP ratio of 60%.

Italy currently has a budget deficit of above 5%, and a debt-to-GDP ratio approaching 150% of GDP.

The issues associated with this have been “kicked into the long grass”.

There are several systemic issues that Ursula von der Leyen will need to contend with as President of the European Commission if the Eurozone ever exits its seemingly permanent state of emergency.

The war in Ukraine and the untimely death while in prison of Russian opposition activist Alexei Navalny continue to bring significant concern to the Eurozone.

With Donald Trump continuing to exert pressure on NATO members over their contributions to the organization’s budget, Europe may find itself exposed to any Russian aggression if Trump wins the Presidential Election.

Some positive news for the region has been the slowing of wage growth, which marks a significant shift from previous quarters. The ECB may want to see this confirmed by the quarterly data, which was due for release last April, but there are positive signs that there may be a rate cut by the end of the second quarter.

The Euro benefited from the lack of follow-through by the dollar recently. Yesterday, it rallied to a high of 1.0839 and closed at 1.0810. Should the FOMC follow through with its “threat” to cut rates soon, the common currency may see a sustained, short-lived period of strength.

Have a great day!