25 April 2024: MPC members see inflation at 2%

Managing a country’s monetary policy with only the “blunt” tool of short-term interest rates is challenging.

Andrew Bailey took over as Governor of the Bank of England following an unprecedented period of stability for the economy.

Almost at once, the country was plunged into the COVID-19 pandemic, followed by rising inflation, which was due, in no small part, to the level of support pumped into the economy by a government desperate to avoid a deep and lasting recession.

The Bank of England was the first G7 Central Bank to begin to hike rates and while the MPC may have been a little timid in the incremental size of the hikes it made, the models they were using at the time were not equipped to forecast the pace at which inflation would rise.

Never had so much fiscal support been pumped into the economy, so blaming Bailey and his colleagues for the level of inflation created is grossly unfair.

Looking back, none of the major banks or the Office for Budget Responsibility (OBS)were calling for rates to be hiked at a higher rate, since they were still concerned about the effect of home-working and job losses as businesses collapsed in the wake of the shutdowns.

When Liz Truss became Prime Minister, she was determined to introduce policies that were created to encourage a “rush for growth” and every agency both at home and overseas saw how foolhardy she was being.

In a book that was published recently, she blames Bailey for not providing greater support and actively undermining her. This was not his job, particularly as the Bank of England has been independent since 1997 and has a very specific mandate primarily concerned with controlling inflation.

Current members of the MPC, Jonathan Haskell and David Ramsden have both recently commented in speeches that they believe that inflation will reach the Bank’s 2% target during the Summer and that it will remain close to that level for the rest of the year, a view that is not necessarily shared by the OBS.

This has driven a conclusion that according to Bailey, the MPC doesn’t have to wait until price rises reach the target before rates are cut as long as progress is seen to be made, the first cut will be delayed until there is confidence that inflation won’t be reignited.

Lloyds Bank, which maintains the largest portfolio of mortgages in the country, saw its profits fall by 28% in the first three months of the year. This was caused by the squeezing of the gap between what it pays for deposits and what it can charge for loans. The fall in mortgage rates was the primary contributor.

This had been expected as mortgage costs eased from the highs reached at the start of last year and as more savers moved cash into accounts with higher returns.

Sterling continued its recent rally yesterday as the market continues to believe that a cut in rates will be delayed until late summer, although the rally may be running out of steam.

It reached a high of 1.2469 and closed at 1.2463.

The Fed has a record of only cutting interest rates when the economy is in decline and needs to be boosted.

Jerome Powell is not likely to use historical precedent as a reason for the delay in cutting rates, since he is acutely aware that the number of moving parts in the economy is complex and constantly changing.

Nevertheless, he can draw on this experience to back his argument for rates to remain unchanged while there is no economic reason for them to fall.

Since the cycle of rate hikes ended, which was either by luck or judgement the economy has powered ahead with growth in the last quarter of 2023 and the first quarter of this year easily the strongest in the G7 group of industrialized nations.

However, data that has been published this week for output in the manufacturing and services sectors has not been as strong as in recent months, with manufacturing slipping back into contraction while service output declined.

This has led to renewed speculation that the FOMC, which has professed since last September to be data-driven, may pivot yet again and become marginally more dovish or at least less hawkish at its meeting which takes place next week.

The economy is going to be under a fierce spotlight as the latest data for employment will be released as well as the FOMC meeting. Although the Fed is not allowed to have advanced knowledge of the jobs data, its models are remarkably like those of the U.S. Bureau of Labor Statistics so they will be aware of any significant changes.

One of the concerns that have been expressed by Republican members of Congress and their supporters has been the amount of support that has been pumped into the economy by the Democrat Administration, which has led to record levels of public debt.

The latest support package for Ukraine that was signed into law by President Biden this week will see a more than sixty-billion-dollar boost to the economy.

The new law will allow the Pentagon to send existing weapons, everything from bullets to missiles to tank parts, to Kyiv and then simultaneously backfill that inventory with new manufacturing efforts for US armouries.

There are believed to be 117 production lines in 71 U.S. cities that manufacture for the Pentagon, so the support for the economy will be evenly spread and provide more reason for the Fed to delay rate increases.

This week’s data has placed the dollar on the back foot, but it recovered marginally yesterday rising to a high of 105.95 and closing at 105.81.

The output data that has been published for both the Eurozone and many of its members has shown that the economy may have bottomed out in the weaker economies, while it continues to improve in those that have been less severely affected by the downturn and high interest rates.

There has been a marked improvement in the preliminary PMI data for April, which has seen whispers begin in some quarters that the ECB may be able to delay the cut in interest rates that was widely expected to take place in June.

There is no meeting of the Governing Council scheduled until June 6th, although the Central Bank of Ireland is hosting a “retreat” on May 22nd at which changes to monetary policy are sure to be discussed and there are sure to be members who are happy to discuss their opinions with the press.

Officially, the retreat has been arranged to allow discussions to take place about the progress of the Eurozone’s green initiatives.

The data for wage increases is due to be released imminently, although there is no “official” date for its publication.

The wages section of the output data, which is buried well below the headlines, showed that price pressures are still in the economy, which will decide on a rate cut less straightforward.

Comments from Christine Lagarde and some of the more hawkish members of the Governing Council recently have betrayed a reluctance to confirm that a cut will be made since they feel that they will be opening the floodgates to further cuts which will depend on the future path of inflation.

One further topic that has been exercising the minds of the ECB recently is the introduction of a digital euro. While some of the public has misunderstood the purpose, and mistakenly see it as a cryptocurrency, to all intents and purposes a digital euro will be identical to what is happening with over ninety per cent of all banking transactions currently which take place electronically and are part of the evolution towards a cashless society.

The Eurozone is the first major economy to be considering such a move, with other members of the G7 content to observe the pitfalls that it may experience.

One interesting observation that has been made recently is that Apple’s iPhone technology is incompatible with a digital euro, according to an Italian Executive Board member, Piero Cipollone. This may mean the process is far more involved than was originally believed.

The euro trod water yesterday since there was little reaction to the output data and no one from the ECB saw fit to comment.

The single currency closed just three pips lower on the day at 1.0698.

Have a great day!