8 October 2024: There will be no revival of ultra-low interest rates

Angela Rayner’s plans for a massive uplift in house building have received a boost this week, as figures published recently show a surge in housing starts to their highest level for more than two years.

Following the removal of planning restrictions by the Housing Secretary in September, housing development surged, with the S&P Global Construction Purchasing Managers Index (PMI) rising to 54.3, up from 52.7 in August.

This marks the fastest pace of growth since March 2022.

The construction sector also expanded significantly, driven by substantial growth in civil engineering projects, including energy infrastructure. The overall construction PMI jumped from 53.6 in August to 57.2 in September, the strongest reading in nearly two and a half years.

Economists pointed to the combination of lower interest rates and Labour’s policy reforms as key drivers of this renewed confidence in the construction sector.

While that sector of the economy is thriving, British firms have grown more downbeat overall about the outlook, a survey showed on Tuesday. Concerns about the tax impact of the new Labour government’s upcoming autumn budget and conflict in the Middle East dampened sentiment.

The British Chambers of Commerce said 48% of 5,152 companies it surveyed between Aug. 19 and Sept. 16 reported that taxation was a main area of concern ahead of the budget. This is up from 36% in the previous survey.

Chancellor Rachel Reeves is expected to change the government’s fiscal rules for reducing public debt. This could pave the way for more borrowing, potentially helping to boost investment and economic growth.

Government debt in August hit 100% of economic output, levels not seen sustainably since the early 1960s.

The BCC survey showed that 56% of businesses expected turnover to increase over the next 12 months, down from 58% in the second quarter, and most no longer expected profits to rise.

A founder member of the Bank of England’s Monetary Policy Committee has spoken of his belief that interest rates will eventually “settle” at just above 4% as the ultra-low rates seen immediately before the Pandemic were an “anomaly”.

Markets expect rates to settle at about 3.5%, but estimates are simply educated guesses because the neutral rate cannot be calculated.

In 2022, Andrew Bailey said he expected the neutral rate “to stay low” but last year said economic developments could cause it to “shift up.”

Charles Goodhart told Bloomberg in an interview. “If I had to guess over the next 20 years, I would say I would expect something a little bit higher.” He added that he would also leave the BOE’s inflation target at 2%, rejecting calls for a review of the framework that might lift it to 2.5% or 3%.

The pound has lost ground in six of the last seven sessions as Bailey’s comment that the Bank of England may become more aggressive in its rate cuts going forward hit home.

It fell to a low of 1.3059 yesterday but recovered a little to close at 1.3083.

A soft landing for the U.S. economy has been a topic of market gossip for this entire year, so it is no surprise that economists are now beginning to believe that Jerome Powell will drive inflation down while continuing to see significant job growth.

The “stunning” number of new jobs created in September took the market by surprise, as many analysts had been expecting the headline non-farm payroll figure to come in lower than August’s figure of 142k. In actuality, the August figure was revised up to 159k, but this was dwarfed by the creation of 254k new jobs in September.

After years of the Powell-led Federal Open Market Committee (FOMC) focusing on bringing down price inflation, markets were growing concerned that unemployment might begin to rear its ugly head.

The good news is prompting analysts to hope, if not become convinced, that the U.S. will escape a recession.

However, as a Presidential Election looms, consumers do not yet have the same level of confidence as Wall Street.

Voters do not think about numbers like GDP and have a more practical view of the economy. They believe that pay increases are due to them working harder.

While the reality is people have a higher standard of living for the same amount of work, the perception is people are working harder to stand still.

Former Treasury Secretary Larry Summers said in October 2022 that a recession and unemployment hitting 6% would be necessary for the then-surging inflation to be brought under control.

While inflation hasn’t been wrestled back to its target of 2, it’s not far off. The Bureau of Statistics reported in early September that the CPI had increased 2.5% for all items over the past year.

Reflecting the mood on Wall Street, Goldman Sachs has reduced their view of the odds of a hard landing being followed by a recession to 15%. This is 5% lower than in its previous forecast.

Federal Reserve Bank of St. Louis President Alberto Musalem said yesterday he supports more interest rate cuts as the economy moves forward on a healthy path while noting that it is appropriate for the Fed to be cautious and not overdo easing monetary policy.

“Further gradual reductions in the policy rate will likely be appropriate over time,” Musalem told a meeting of the Money Marketeers of New York University, noting that “patience” has served the Fed well. I will not prejudge the size or timing of future adjustments to policy.”

Meanwhile, Neel Kashkari, the President of the Minneapolis Federal Reserve, commented that the overall balance of risks has tilted slightly into labour headwinds, with progress on inflation continuing.

He went on to say that overall, the US economy is resilient, and the labour market still looks strong, we want to keep it that way. A reduction in new rent inflation provides confidence that housing inflation will come down over the next 12–24 months.

Kashkari is not a voting member of the FOMC this year.

The dollar index continues to gain as the market digests the September employment report. It rallied to a high of 102.67 yesterday but closed at the same level as Friday at 102.49 as short-term traders took profit on long positions.

ECB Governing Council member, Martins Kazāks believes that the Central Bank will continue to use twenty-five basis point interest rate cuts to stimulate growth in the Eurozone economy and not resort to the tactics employed by the Federal Reserve. He did provide a caveat by saying that his view is only valid if the economic situation does not weaken.

In an interview on the margins of the annual conference of the Central Bank of Latvia, which he heads, Kazāks, who provided his comments on Sunday, strongly supported an October cut but declined to venture an explicit guess as to what would happen in December. ‘If we see in October that we can cut rates, and I think we can, then we will do so’, he said.

What we do in December, when we have a new set of projections that will include the first quarter of 2025, will be decided nearer the time.

Eurozone inflation is increasingly likely to ease back to the European Central Bank’s 2% target on a more permanent basis, ECB board member Isabel Schnabel said yesterday, dropping her long-standing warning about the difficulty of the “last mile” in taming price growth.

Inflation dipped under 2% last month and economic growth is weakening, so markets are already betting that the ECB will speed up interest rate cuts, with its next move seen happening next week.

“We cannot ignore the headwinds to growth,” Schnabel said in a speech in the German town of Freiburg.

“With signs of softening labour demand and further progress on disinflation, a sustainable fall of inflation back to our 2% target promptly is becoming more likely, despite still elevated services inflation and strong wage growth,” she said.

The market believes that inflation will remain sustainably at 2% significantly more quickly than the official ECB prediction of late 2025.

Markets see about a 90% chance of a 25-basis point cut in the 3.5% deposit rate later this month, coming on top of moves in June and September.

Piero Cipollone, the Deputy Governor of the Banca d’Italia, is another who believes that a rate cut will happen at next week’s meeting of the Governing Council.

Cipollone, who will take up a position with the ECB’s Executive Council next month, said recently “We could get a growth that is a little bit slower than what we were thinking, and also numbers we are seeing on inflation seem to be pointing to the fact that prices are decelerating faster, faster than we expected.”

“We have seen a deterioration of the PMIs recently, so the signals coming from the real economy are a little bit weak,”

The Euro bounced off its short-term support level yesterday. It reached a low of 1.0954 and closed at 1.0974

Have a great day!