5 April 2024: The recent wage boost may delay rate cuts

Data published this week has provided the market with a sense of optimism that the economy is indeed on an upward trajectory, as the Prime Minister has suggested recently.

Preliminary PMI data has shown that manufacturing activity has moved into expansion for the first time in many months, driven partly by an increase in the desire of UK companies to “buy British”. Furthermore, although there was a marginal decline in the latest figures, services output is now firmly in expansive territory. This has led the composite data to continue to show improvement.

The housing sector is “holding its own” with data for mortgage approvals that was published yesterday, showing that approvals rose to £60.823 million from an upwardly revised £58.08 million.

Andrew Bailey has encouraged the market to believe that an interest rate cut is “around the corner” as the headline rate of inflation continues to fall.

The two members of the MPC who have been concerned about the possibility of a rate cut reigniting inflation, both voted for rates to remain on hold, with one, Catherine Mann, commenting that the balance of risks in the UK economy is now balanced between inflation and recession is now roughly equal.

The next MPC meeting is scheduled to take place on May 9th. At this meeting, the latest monetary policy report will be published that will indicate how many cuts in rates the Bank is expecting to take place this year.

Given the current uncertainty that surrounds wage demands, particularly in the public sector, with teachers again voting to take industrial action later in the year a cut in rates is considered unlikely at the May meeting.

The next meeting is scheduled to take place on June 20th and there is a genuine expectation that this will be the meeting when Bailey “pulls the trigger”.

The prospect of a General Election has been hanging over the economy for several months, with the Labour Party so far ahead in the polls that anything other than a Socialist victory is barely considered.

The electorate has tended to trust the Conservative Party with the economy more than Labour, given the Tories’ record of low taxation, but that has changed under the present administration, with the tax burden on both companies and individuals being at its highest level for seventy years.

If Labour is given the keys to 10 Downing Street, it won’t have a great deal to work with, and so far, has now announced any radical new policies to turbocharge business activity. A feel-good factor will likely be generated during its honeymoon period as the Bank of England obligingly undertakes a series of rate cuts.

It may be that the Labour Leader, Sir Keir Starmer, plans to foster a closer relationship with the European Union if he feels that the tide has turned, and the country now feels that the vote for Brexit was a mistake.

The rise of the Reform Party which is now a solid third in the polls will undoubtedly dilute the Conservative vote, given its more right-wing agenda which includes cutting any remaining links with Brussels.

The pound rallied initially to a high of 1.2683 yesterday, but it quickly ran out of steam and settled back to close at 1.2642 and is now likely to close marginally lower on the week.

The market is awaiting the publication of the March employment report later today. The jobs data released so far this week has been generally encouraging. Still, given the significant number of estimates in the more comprehensive non-farm payroll data, any correlation is often driven by coincidence rather than any genuine parallel.

The Fed will be just as interested in the wages and hours worked data as it is in the headline number of jobs created.

As inflation has continued to fall in G7 nations, the Central Banks have tended to look at wage data for indications of inflationary markers hidden within their economies.

Several members of the FOMC have made speeches this week, with Daly, Goolsbee, and Mester, all expecting any rate cuts to wait until the third quarter to ensure that inflation is no longer an issue.

They all agree, however, that there will be three cuts this year, although Bostic believes that the inflation picture may only allow a single cut which will take place in the fourth quarter.

Jerome Powell spoke again yesterday and was a little more reticent about rate cuts than he has been recent. He didn’t allude to how many cuts will take place, just that there is room for a cut later this year, even as inflation rose in January and February.

Neel Kashkari, the President of the Minneapolis Fed and a former Assistant Secretary of the Treasury, floated the idea yesterday of no cuts being possible this year.

Kashkari has a reputation for being a realist, not aligned with either the dovish or hawkish faction on the FOMC.

He said yesterday that he has “pencilled in” two rate cuts this year but can accept that if no rate cut is possible due to a lack of progress on inflation, he will look at any proposal on its merits.

He feels that every possibility is on the table and the Fed has the opportunity to remain data-dependent for the rest of this year.

The dollar index fell to test its support at 103.90 yesterday, reaching a low of 103.91. It bounced off that level to close at 104.22, as the market squared positions in anticipation of today’s data.

This week, for the first time, the idea of rate cuts affecting one another data has been floated. The Governor of the Austrian Central Bank, Robert Holzmann, spoke of his view that the beneficial effect of an imminent cut in rates will be negated if the Fed continues on hold, and the Euro suffers a significant fall.

This is the first time that any G7 Central Banker has alluded to the risks to the currency market of rate cuts.

Given that the “smart money” sees the ECB and MPC as “neck and neck” in the “rate cut sweepstakes”, with the Fed now unlikely to cut until September, at the earliest there is a clear risk to both the Euro and the pound.

Any delay by the Fed while their G7 partners begin to cut rates will affect competitiveness, although it may well have a beneficial effect on inflation.

Holzmann went on to say that he believes that it is time that the ECB began to stop subsidizing commercial banks and should cut interest payments on the piles of cash lenders got from the central bank on the cheap.

He believes that the ECB should not run deficits without an end in sight.

During its programme of QE, the ECB “printed” billions of Euros to enable it to buy Government debt to support the economy, hoping that it would support the economy and push inflation back up towards 2%.

That policy backfired spectacularly, with inflation becoming close to out of control and causing interest rates to be hiked to time-high levels, which caused infinitely greater damage to the economy.

The ECB will be interested to see if this week’s fall in inflation continues, but it is still more interested in some downward momentum beginning in the level of wage increases.

Several Eurozone nations, including Italy, Spain, and Portugal, have agreed inflation-busting wage increases for their respective public sectors which have offset the tightening of monetary policy to a degree.

The Euro hasn’t reacted to the most hawkish member of the ECB’s Governing Council accepting that a rate cut is closer] to becoming a reality, but once today’s data is out of the way and the Fed’s path becomes clearer, the common currency may resume its downward path.

Yesterday, it rallied to a high of 1.0876 but ran out of steam and fell back to close at 1.0837 just one point higher on the day.

Have a great day!