23 August 2024: Inflation rise may delay a rate cut

The Bank of England can afford to wait before cutting interest rates to allow inflation to settle back down.

Having seen prices rise again by 2.2% in July, following two months when they had been at the Bank’s target of 2%, the vast improvement in both growth and economic activity means that the next cut can wait.

It is interesting to note that while consumers feel better about their finances following the rate cut agreed by the MPC last month, they are still unsure about the continuing strength of the economy.

The wage settlements handed to several sectors of public service workers have reminded voters that although it was clear that it was time for a change of Government, Labour’s age-old issues may well raise their heads again.

Chancellor Rachel Reeves faced the issue head-on yesterday as she told reporters that the Government won’t hand Public Sector Unions a blank cheque as the Opposition accused it of being a “soft touch” having acceded to demands for above-inflation pay increases during its six weeks in office.

Jeremy Hunt has been stung by accusations over his handling of the economy which has led to a major black hole in the nation’s finances.

He said recently that the increased level of growth that has been seen since the start of the year will provide a significant increase in tax revenue, while the level of unemployment will see fewer people claiming benefits going forward.

Both these positives will negate the need for tax increases in the October Budget, but according to Hunt, Reeves “simply cannot help herself”.

Reeves maintains that there was no “caving in” to the demands of train drivers or junior doctors, while she simply followed the recommendations of independent review bodies in giving pay increases to the armed forces, nurses, and teachers.

In an interview yesterday, Reeves said that she wants to be seen as the Chancellor who took “tough, bold, and correct decisions.

Reeves is still under pressure from several of the new Labour members of Parliament, who represent some of the most deprived areas of the country and didn’t benefit from the previous Government’s levelling up initiatives, to scrap the two-child benefit cap.

The pound has benefitted from a belief that the Bank of England may pause its cycle of cutting rates when it meets in the Middle of next month, while it expects the Federal Reserve to cut U.S. interest rates, a theory that will be put to the test later today.

Sterling rose to a new high of 1.3130, although it closed almost unchanged at 1.3091.

Fed Chairman Jerome Powell will make arguably one of the most important speeches of his tenure in office later today, as the market continues to believe that the time has come for the Central Bank to loosen monetary policy.

Over the past year, Powell has constantly been a dissenting voice regarding interest rate cuts as economists, Wall Street Bankers and investors have at various times shown their concerns that the economy may be forced into recession by the FOMC’s continued insistence on defeating once and for all the curse of inflation.

The July employment report showed that just 114k new jobs were created, down from an already revised figure of 179K. Furthermore, 881k new jobs were created in the year to March, which was a reduction of the published figure of a little over a million.

Finally, the minutes of the last meeting of the FOMC showed that although comments are not attributed, several members of the Committee felt that rates should be cut at that meeting, and when that demand failed to attract a majority, demanded that if the data does not provide any upwards surprises that a cut should happen in September.

There are two factors against a rate cut happening in September, besides Powell’s continued hawkishness. The first is that the Fed has never cut interest rates against a backdrop of a growing economy and second, inflation still has not met its 2% target.

Even if Powell does not support a September rate cut, traders may still believe that his hand will be forced by another weak employment report for August and a fall in the rate of inflation in August.

This year’s Jackson Hole theme is “Reassessing the Effectiveness and Transmission of Monetary Policy.” Powell will speak at 3 pm BST, in front of central bankers, policymakers, and others, continuing the tradition of Fed chairs delivering keynote addresses.

Typically, the event does not focus on announcing interest rates or policies. However, the “stars appear to have aligned”, allowing Powell to break with tradition.

The dollar’s recent fall slowed a little yesterday as the market became a little oversold and traders reined in their expectations of a dovish speech from Powell.

The index rallied to a high of 101.62 and closed at 101.51.

It seems to be a moot point that the Eurozone economy has been on the cusp of slipping into a recession for most of this year.

The ECB continues to have a laser focus on inflation and will not shift its present course even if it did, in a moment of weakness, agree to a twenty-five-point rate cut in July.

There is a feeling that Christine Lagarde overstepped her authority before the last meeting of the Governing Council when she virtually confirmed in advance that there would be a rate cut.

Although the minutes of the meetings are not published, as they are in the U.S. and UK, it is fairly obvious from comments made by hawkish members of the Council subsequently, that they were faced with an impossible situation and considered a rate cut to be the “lesser of two evils” since there had been significant progress made in reducing the headline rate of inflation.

It is doubtful that they will want to be backed into a similar corner again, and with inflation picking up again this month, a further rate cut is expected to be delayed.

Including next month’s meeting, there are just three meetings of the Governing Council remaining in 2024, and it is a close call on how much lower rates will be in the U.S. and Eurozone by the end of the year.

The Eurozone economy has received a boost from the hosting of both the Euro24 football tournament and the Olympics in the region this summer, but industrial output has continued to suffer.

A rate cut would provide a genuine boost to that sector of the economy, but unless inflation begins to fall again, that may not happen until the fourth quarter.

The Euro’s seemingly unstoppable march higher came to a halt yesterday, and traders will have to wait until later in the day to see if the halt is permanent or simply a pause for breath.

The single current fell to a low of 1.0198 and closed at 1.1112.

Have a great day!