27 March 2024: Just as a cut seemed “on the cards”

Just when the market had become comfortable that the Bank of England would begin to cut rates soon, possibly at the next MPC meeting, as Catherine Mann and Jonathan Haskell had both voted for rates to remain on hold, Mann dropped a bombshell yesterday by saying that not only would the Bank be unlikely to cut rates as many times as the market expects, but the first cut is likely to be after the Fed begins to cut.

Given that the Fed is believed to be considering that the first cut in rates would take place in September, the outlook for the UK economy has changed dramatically.

Of course, Mann remains in a minority of members of the MPC who have a hawkish outlook, her views do, however, echo the recent comments of the Bank’s Chief Economist, Huw Pill, who commented recently that the Bank will want to see more evidence that the fall in inflation is more than “modest and tentative” given the strong underlying domestic price pressures that exist.

Mann went on to say that “wage dynamics in the UK are stronger and more persistent than the wage dynamics in either the United States or the euro area”.

While Mann’s comments cast a shadow over the prospect of an interest rate cut next month, and possibly, next quarter, the fact remains that in his most recent press conference, Bank of England Governor Andrew Bailey said that a cut in interest rates is “in play”, and inflation is heading inexorably toward its target, and it won’t necessarily have to reach 2% before the Bank begins to cut rates.

The interest rate futures market still believes that the Bank of England will be the first G7 Central Bank to begin to cut rates. There is still only a 20% chance that the first cut will take place by May, but only a 10% chance for the Fed or ECB.

The Credibility of the Bank of England has been shredded since Andrew Bailey became Governor. Despite being the first G7 Central Bank to start to raise rates in December 2021, that is still considered to have been too late given the rapid rise in inflation, and there is a view that they raised them too high, and now they may well be leaving them unchanged for too long.

It is true that if the first hike had been sooner and the increments had been greater, inflation may well have come under control sooner, but that is a matter of conjecture given the outside pressures that existed at the time.

Mann’s comments gave Sterling a boost. Yesterday, the pound rose to a high of 1.2668, although it ended the day lower overall at 1.2628.

The prospect for an interest rate cut in any G7 economy is still a “moveable feast. At the turn of the year, the market was confidently predicting that at least one, and possibly two Central Banks would have taken the plunge by the end of the currency quarter, but those hopes have now been dashed.

Raphael Bostic, the President of the Atlanta Federal Reserve, has already said that he is prepared to wait before voting for a rate cut. This week, he went on to say that he doesn’t see more than one cut in rates this year. This is contrary to the Fed’s “official” outlook that there will be three cuts. Bostic sees the economy as remaining “robust” and says a series of cuts may not be justifiable.

The dollar began the year strong, but that strength began to fade in mid-February as it was felt that the FOMC was leaning towards an early cut in rates. Over the past month to six weeks, the dollar has regained its momentum as it has emerged that the FOMC is in no hurry to cut rates.

The core rate of inflation has barely changed over the past couple of months, and the Fed will still want to see considerable progress toward its 2% target before it declares its “war” against increasing price rises is at an end, and victory is declared.

Although the market concentrates on CPI as a gauge of inflation, the FOMC and, more particularly, its Chairman Jerome Powell prefers the PCE data which offers a more all-round view of the price pressures in the economy, particularly since it considers the real estate market.

The latest PCE data is due for release this week and the market is beginning to “mark the date” in its collective calendar since if the data is going to influence the FOMC it needs to be taken notice of.

The QoQ data for Q4 is due for release on Thursday and is expected to be unchanged, with the rate still being at 2.1%.

Q4 GDP data is due to see its final adjustment also on Friday, although it is expected to remain as previously reported at 3.2% which will give the Fed some comfort to keep rates unchanged.

The dollar index attracted some buyers following its unexpected fall on Monday. It reached a high of 104.33 and closed at 104.30.

Spain delivered a very respectable rate of growth for the final quarter of 2023 and is expected to continue throughout 2024. The Spanish economy grew by 2% last year, making the country the Eurozone’s shining light.

The Spanish economy has responded well to the return of tourists from both Northern Europe and the UK.

Several Banks noted the improvement in the outlook for the Country with economists at Dutch Bank ING noting that “we’d previously seen signs that growth was picking up as several soft indicators (such as business sentiment) improved toward the end of 2023 – but this growth far exceeds expectations. GDP came in much higher than market expectations of 0.2% QoQ.

This marks a notable change in the makeup of the eurozone economy since it was previously felt that if Germany stutters, the entire region will be unable to grow.

The virtual stagnation of the German economy is not now proving an obstacle to the Eurozone.

It remains to be seen if growth in Spain tails off a little since tourist numbers are unlikely to see the exponential growth, they saw between 2022 and 2023.

The Irish economy is also expected to return to growth, as one of the region’s smallest but most volatile economies has seen its issues over Brexit fade.

The latest data shows that the Irish economy grew by 0.5% in 2023. Ireland is in an awkward position in that it still does 23% of its trade with the UK and an even greater amount with the U.S. That makes it unique within the Eurozone. More than 50% of Irish GDP now comes from the services sector.

This is a significant change from its traditional agricultural background and shows how Dublin has managed to make Systemic changes to its economy in the recent past.

Meanwhile, the German economy is still in a serious funk. Heavily reliant on energy-hungry heavy industry and seemingly unable to make the necessary changes.

It may well be that the necessary changes may come from both Germany and the Eurozone’s reaction to Russian Hegemony. The Eurozone still looks to NATO to be its main defender, but it may need to look at creating a single Eurozone defence policy, particularly if Trump wins the Presidential Election.

Trump is less appreciative of the role that several Eurozone nations play in NATO than incumbent President Biden. He is certain to want to amend the structure of NATO if elected, and that may leave the Eurozone exposed.

The Euro lost ground yesterday as the outlook for rate increases changed yet again. After a bright start, it fell to a low of 1.0824 and closed at 1.0831.

Have a great day!