22 March 2024: Bailey wants more evidence of falling inflation

The Bank of England has changed the rhetoric of its guidance to markets about when the first rate cut will take place, but the message remains the same. Following recent meetings of the Monetary Policy Committee, Andrew Bailey often told journalists that the Bank was “prepared to be guided by the data.” Now that the data is favouring a cut in rates, the Committee wants to be sure that the data can be “trusted.”

This is leading to continued further speculation but as the economy stutters and the inflation continues to fall economists are trying to agree what the trigger will be to make the MPC “take the plunge.”

Following this week’s inflation data which saw the fall in headline price increases exceed expectations, and taking Baileys’ recent comment that inflation needs to be firmly on a downward trajectory, but not necessarily at or below the 2% target for rate cuts to begin, the market believes that a fall below 3% will trigger the first cut.

That is almost certain to be at the May meeting since it is unlikely to happen next month.

The meeting which ended yesterday was the first since February 2022 where no one voted for a hike in rates. In his press conference, Bailey commented that in recent weeks we’ve seen further encouraging signs that inflation is coming down.

“We’ve held rates again today at 5.25 percent because we need to be sure that inflation will fall back to our 2 per cent target and stay there. We’re not yet at the point where we can cut interest rates, but things are moving in the right direction.”

The order in which G7 Central Banks will “pull the trigger” has been changing as they continuously amend their guidance. Currently, the order is BoE, ECB, and Fed, with cuts in May, June, and September.

The data that was published yesterday provided a further indication of the improving state of the economy. Although services activity fell from 53.8 to 53.4, it remains in an expansive state, while manufacturing output is on the cusp of expansion, climbing from 47.5 to 49.9 this month. The PMI data is preliminary, but there is no reason that these numbers won’t be confirmed.

Sterling lost ground following Bailey’s comments. Versus the dollar, it fell to a low of 1.2650 and closed at 1.2661.

It has emerged that despite the overt hawkishness of the ECB, the Fed is likely to be the last G7 Central Bank to cut rates, for the simple reason that no matter how scared officials are of inflation, it will always be how the economy performs that has the final say.

With the U.S. economy continuing to outshine the Eurozone in every area except employment, the FOMC can be truly data-dependent and ensure that inflation is no longer a threat before it commits to a programme of rate cuts.

The wiggle room that this has created means that the Fed is now considered unlikely to cut rates before its September meeting when inflation is slated to have met the 2% target.

It was considered that the first sign of any slowdown in the economy would take place in the real estate sector.

While commercial space continues to struggle for traction, the home sales market for new property and existing homes is surprisingly buoyant. Data published yesterday showed that existing home sales rose 9.5% last month, following a 3.1% rise in January.

Both manufacturing and services output remains firmly “in the black” although preliminary data showed both moderated slightly this month.

Weekly jobless claims are close to the top end of their long-term average but appear to have plateaued. It is likely that the longer the Fed avoids cutting rates that the market, the more the employment market will adjust and react less when rates are cut.

The Fed is planning to increase its supervision of counterparty risk as its Vice Chair for Supervision, Michael Barr, spoke yesterday of how banks would deal with the systemic risk inherent in the collapse of a large hedge fund as was seen in 2022.

Clear, the Fed is “cleaning house” while the FOMC remains on hold. This eminently prudent action contrasts with the ECB, which prefers to deal with one issue at a time.

The dollar index reacted positively to the Fed remaining on hold. It climbed to a high of 104.05 and closed at 104.01.

The ECB may have backed itself into a corner by recent comments from certain officials that a rate cut be dependent on the Q1 jobs data, which is due in late May. While it is considered certain that between January and this month, the Eurozone jobless rate will have risen while wage settlements have been close to, or even below the rate of inflation, a problem will arise if the data is not as expected.

It is hard to imagine that job creation can grow at its present rate given the level of interest rates, but the data is notoriously unreliable. However, it will be the inflationary effect of settlements remaining above the rate of inflation, particularly since the economy is going through a phase of disinflation currently, which should see wage settlements fall.

This is another indication of the lack of a fiscal union and something the European Commission will need to address sooner rather than later.

Given the turbulence that has affected the economy recently, there may well be some pushback against closer integration of Eurozone economies, since the lack of fiscal unity offers a trade-off against the worst ravages of tight monetary policy and allows some members to maintain imbalances in debt-to-GDP ratios and budget deficits.

Christine Lagarde has commented the ECB is unable to commit to a particular path of interest rate cuts once it starts to ease monetary policy, despite signs that wage growth has peaked in the eurozone.

While other G7 Central Banks feel able, possibly even committed, to a level of advance guidance which provides that market with some degree of comfort that once they cut rates there will be no “nasty” aftershock in terms of inflation, it seems that the ECB, particularly the hawkish members of its Governing Council and Executive Board are not prepared to provide such assurances.

At its June meeting, the ECB will also provide updated economic forecasts. They will allow the Market to confirm (or otherwise) the validity of the projections that are published at its most recent meeting.

It does seem that the ECB is moving inexorably towards a rate cut in June, and the Euro is gradually reflecting on the loss of a major plank of support.

Yesterday, the single currency fell to a low of 1.0855 and closed at 1.0860.

Have a great day!