7 November 2023: Interest rates have peaked, when will they fall?

Although the Bank of England has in all probability ended its cycle of interest rate hikes, the market is still infatuated with monetary policy.

The Bank’s Governor faced a barrage of questions at his press conference last week about when the Bank will begin to bring interest rates lower. Especially given his assertion that inflation will begin to recede markedly beginning with the data for October wish is due to be published on October 15th.

However, while several major bank economists believe that the Bank should be considering a cut in rates to provide a boost to the economy, the minutes of last week’s meeting indicate that last week’s decision amounted to a “hawkish hold”.

Even though the vote was 6-3 in favour of a pause the minutes showed that the majority while voting for a pause agreed that rates should remain “elevated “for a significant period.

One member of the committee, presumably Swati Dhingra, who has never voted for an increase in over a year of membership, believes that the effects of earlier tightening are still coming through due to the lag in the delayed impact on the economy.

With the outlook for the economy looking bleak, lenders are taking precautions to avoid a spate of non-performing loans. Several mortgage providers are content to provide funding but have reduced the LTV (loan to value) that is available to receive the lowest rates.

To obtain a rate of 5.75% on a two-year fixed deal, borrowers must supply a 25% deposit, while a 20% deposit attracts a rate of 5.80%. Lenders see the market as stabilizing after the mayhem of the past year, but security is becoming more of a factor. Lenders are keen to avoid the level of negative equity that has been seen during other economic downturns.

Later today the King officially open Parliament delivering a speech provided by the Prime Minister setting out the Government’s agenda for the new session of Parliament.

This is the first opportunity, and maybe the last, that Rishi Sunak has had to set out his agenda for the coming year.

Most of the agenda for the economy will be dealt with by the Chancellor in his Autumn statement later this month, the King will announce a more general set of proposals including raising the minimum age for smokers by one year every year , and several pieces of law enforcement legislation including a redefinition of the law relating to demonstrations.

The pound lost ground yesterday as the dollar began to reassert itself following Friday’s reaction to the U.S. employment report. It fell to a low of 1.2342 and closed at that level.

The Chairman of the Federal Reserve is among several members of the FOMC who are due to deliver speeches this week. Following the “blackout” that occurs for one week prior to the meeting, it is some time since the more dovish members of the Committee have been heard.

It is well known that Jerome Powell is still among the most hawkish members, but he appears to have been constantly outvoted recently. Powell believes that rates should not only remain high for a considerable period, but the FOMC should consider one final hike before year-end.

He is unlikely to get his wish since it would be highly unusual for the FOMC to connoisseur a hike after Thanksgiving. The next FOMC meeting is scheduled to take place on the 13th of December.

There is a tradition that Central Banks do not like to raise rates in the run-up to the Christmas holiday. One exception was the Bank of England which began its cycle of hikes in December 2021.

The speculation about when the first cut is rates will take place has begun despite there having been non confirmation that the Fed has finished hiking and retaining a “tightening bias”.

Wael Kashkari, the outspoken President of the Minneapolis Fed, agrees with the stance taken by Powell. He spoke yesterday of his belief that the Fed has more work to do to control inflation and is not convinced that the cycle of rate hikes has ended.

Powell and Kashkari are in a minority since other members of the Committee have a more “regional” view of the economy.

The Fed’s lending survey which was published yesterday showed that Banks are also tightening lending standards much the same as in the UK. The survey showed that additional security is being demanded for corporate loans, particularly when related to real estate, while households are becoming more wary of taking on more debt.

The dollar has recovered its poise following the October employment report which pointed to the cycle of rate hikes finally having a substantial effect on demand.

The index climbed to a high of 105.29 and closed just one pip lower.

The victory for the more dovish members of the rate setting Governing Council of the ECB appear to have been harder fought than had previously been assumed.

Robert Holzmann, the Head of the Austrian Central Band and by far the most outspoken hawk on the Council spoke yesterday of his view that the ECB must remain vigilant and be prepared to raise rates again soon.

He went on to say that a rate cut is out of the question and should not even be discussed for fear of giving the wrong impression.

Rates have been increased by a total of 450 basis points since July 2022 in a run of ten consecutive hikes. Holzmann declared himself not to be a member of the group who feel that victory in the war with inflation should be declared and that the ECB should be careful not to reignite the fuse that will lead to a flare-up in consumer prices.

It appears that the beginning of winter and any possible repeat of the energy crisis as well as the potential for the wars in Gaza and Ukraine to create shortages of fundamental items are his major concerns.

Holzmann welcomed the fall in headline inflation that was published last week, but until there is a trend established, he will remain wary. He sought to cool growing expectations of a rate hike in the first quarter of next year. He feels that cuts will come but there is too much uncertainty remaining.

When asked about his concerns for the economy, he repeated that inflation is still a more serious threat than a period of stagnation. Stagnation is preferable to stagflation.

Data for services output was released yesterday and showed that that sector of the economy remains in contraction, although the situation has nor worsened as recent rate hikes continue to feed into the economy.

Tomorrow retail sales data for the Eurozone is due for release and the market is bracing itself for another poor figure, following last month’s fall of 2.1%, the consumer appears to have entrenched even more with retail sales expected to have fallen 3.2% year-on-year.

The euro was unable to consolidate the gains it made on Friday and fell back to a low of 1.0717 and closed at 1.0719. Traders appear in no hurry to re-establish short positions having seen their stop losses triggered. Until a trend can be seen the market is expected to remain in narrow ranges.

Have a great day!