9 April 2024: Data should lead to a rate cut

The latest data for wage growth show that increases have fallen to their lowest level since the middle of 2020. This satisfies the more hawkish monetary policy committee members that there is likely a significant rise in demand driven by a loosening of monetary policy.

Bank of England Governor, Andrew Bailey, has been more pragmatic about the prospect of a cut in interest rates recently. He acknowledges that there is an economic need for rates to be lowered, even though his preference would be for inflation to have fallen to the Bank’s 2% target.

His comment that inflation does not have to have fallen to that level before rates are cut if it is consistently moving in the right direction, has led the market to believe that the Bank is committed to cutting rates.

The next opportunity for the first cut to take place is at the meeting which takes place on May 9th, however, there was no indication at the meeting a little over two weeks ago that the committee is happy that prices are at a level where they would be comfortable cutting rates, and the market expects that there will be a significant amount of advance guidance provided that a cut is imminent.

The concern that a wage/price spiral was beginning which would see inflation climb due to the additional costs firms incurred that would force them to raise prices, which in turn led to businesses facing demands for higher wage increases which created a seemingly endless round of higher wages and prices appears to have eased. This should see one of the major concerns of independent MPC members Catherine Mann and Jonathan Haskell removed.

At the meeting of the MPC scheduled for June 20th, sufficient evidence should have been presented that will allow rates to be cut by an expected twenty-five basis points.

The economy has reached something of an impasse over the relationship between wages and prices, and it will take a “leap of faith” for rates to be cut given the current environment. Having been stoic in keeping rates at their current level as inflation has more than halved since the rate increases were ended, Bailey wants to be sure that he won’t be blamed for any short-term rise in inflation following the first cut.

The pound is capped around the 1.2680 level by some significant sell orders. It has tried and failed to break higher three times over the past week, and now short-term traders are seeing an opportunity to establish short positions around that level.

There is no trend discernible for the medium-term path for Sterling, and it is expected that nothing will change until rates are cut.

The pound rallied to a high of 1.2664 yesterday, closing at 1.2654.

There is speculation around Washington That the Administration is pressuring Jerome Powell to keep rates at their current level and not cutting until the Presidential race is well underway to show that President Biden’s economic policies have driven equity markets to the level they will doubtless see once monetary policy is loosened.

While that is unquestionably a ploy used by supporters of former President Trump, Powell has not shown any political inclination during his two terms as Fed Chairman.

He has been unique in that he was seen as the “best man for the job” by President Biden when he came up for his second term in office, despite being a member of the Republican Party shows the esteem in which he is held by the Treasury Department and its Secretary, Janet Yellen in particular.

The Fed Chairman went out of his way to drive that point home last week while delivering a speech that devoted more time to discussing the Fed’s independence from personal or political bias than it did interest rates or inflation.

“Fed policymakers serve long terms that are not synchronized with election cycles,” Powell said while speaking to an audience at Stanford University. “This independence both enables and requires us to make our monetary policy decisions without consideration of short-term political matters.”

When questioned about his and his colleagues’ political allegiances, he commented that the Committee leaves politics “outside the office door”.

There is no doubt that the FOMC is going to have the luxury of being data-dependent until well into the Summer, and it may even be after the Labor Day holiday before they will need to consider cutting rates.

It is interesting to note the most pressure being placed on Powell’s shoulders currently comes from a Democrat Senator. Elizabeth Warren, who, despite the robust growth being experienced by the economy over the past six months, has been calling for rates to be cut as a matter of urgency.

She has used the delay in clean energy advances to call for a rate cut. In a recent letter to the Fed Chairman, she wrote, “We urge you to cut interest rates throughout 2024 to allow for continued progress on clean energy projects and the climate and economic benefits these projects provide”.

As long as the FOMC retains its relatively hawkish stance on interest rates, the dollar index will remain supported. It lost a little ground yesterday but is still within a narrow range. It fell to a low of 104.09 yesterday and closed at 104.13.

It is as well that the ECB appears to be committed to a rate cut in the coming months since the data for both economic output and sentiment is beginning to illustrate that the Eurozone may be coming through the worst of its inflation-led slowdown and there are “green shoots of recovery”.

This may well have caused it to reconsider the path to rate cuts that it has embarked upon.

In Germany, data for industrial Production that was published yesterday showed that the year-on-year contraction is slowing, while month on month the economy is showing a new-found resilience.

In February, output rose by 2.1% following a 1.3% rise in January. Although the German economy is “crying out” for systemic changes, they will only be delivered by a change in government, while in the short term, it will have to rely on its traditional industries despite the pressure being exerted by geopolitical events.

The meeting of the ECB’s Governing Council that is scheduled to take place in Frankfurt on Thursday may well produce a watershed event. While at just about every meeting for the past six months, Christine Lagarde has provided reasons why the Bank should not be cutting rates, it is likely that this week she will outline the conditions necessary for a cut to take place at the next meeting, scheduled for the 6th of June.

That data will always be significant for Europe and could be D-Day for the Eurozone economy.

The ECB has caused an almost 14% fall in the value of Government bonds over the past three years. While its zeal in fighting inflation is understandable, pushing rates to a record high of 4% may have been excessive.

We will never know if the last two or three hikes were necessary, but the anecdotal evidence provided by the pace at which inflation has fallen close to the ECB’s 2% target shows that the significant slowdown in activity could have been avoided.

It remains to be seen just how aggressive the ECB will be in cutting rates. Given the green light for cuts to begin that has been provided by recent comments from even the most hawkish members of the Governing Council, at least one hundred basis points of cuts are considered likely.

The hawks will need to hold their nerve if the rate of fall in inflation slows, or prices begin to tick up marginally. Having committed to cutting rates, they will need to see it through to the end.

The Market sees the ECB as the “boy who cried wolf” and is still prepared to support the single currency until it witnesses a cut “with its own eyes.”

Yesterday the Euro rose to a high of 1.0862 driven primarily by commercial buyers and closed at 1.0859.

Have a great day!