9 May 2024: The chances of a rate cut are fading

The Bank of England’s Monetary Policy Committee has been meeting this week, and an announcement of the outcome of its decision will be made later this morning.

There is little chance of the base rate of interest being cut since the fall in the level of inflation has stalled. This is the case in most G20 nations, as consumers continue to spend despite the continuing cost-of-living crisis. While the level of interest rates has dampened demand, it is only now that unemployment has begun to “tick up.”

Santander, NatWest, and Nationwide have all raised the rate they charge for fixed-rate mortgages this week.

The vote is expected to be 8-1 in favour of leaving rates unchanged, as they have been since August last year. The pressure for cuts to begin has intensified, particularly since the start of the year, with the economy still struggling to make any headway.

The growth outlook is still tepid at best, with economists at the IMF predicting that although they do not expect the economy to fall into recession this year, they only see GDP growth at 0.5% this year with a slightly better performance in 2025.

The great imponderable is the election which is due to be called by the Prime Minister later this year. Although it is unlikely that a change in Government will see any instant improvement in GDP this year, with the Labour Party remaining coy regarding changes they will make in the early days of the new Parliament, it is almost impossible to make predictions.

Although Rishi Sunak had little choice but to “take it on the chin” during Prime Minister’s Questions in Parliament, his task was made much more difficult by one of his MPs defecting from the Government benches to the Opposition.

Natalie Elphicke has been fiercely critical of Labour’s policy on immigration, with her decision announced moments before Starmer and Sunak faced off.

There was unease on the Opposition back Benches as MPs questioned the need to accept some with “conservative values” at the heart of their views, while Conservative MPs commented that on several issues Elphicke stood to the right of many of them.

Last week’s local election results were the main topic of the session, with Sunak facing the arduous task of trying to put a brave face on what was an obvious disaster, although it was one that he had plenty of time to prepare for. He tried to lean on the fact that local elections often have a vastly different outcome to general elections, given the different focus of voters.

The pound is unlikely to be affected by the outcome of today’s MPC meeting since there has been no indication of a mass change of heart from its permanent members.

Sterling fell to a low of 1.2467 yesterday, testing the bottom of its recent range. It managed to claw back some gains late in the day, closing at 1.2497.

Over the past fifty years, there have been many instances of the market ignoring the advance guidance provided by the Federal Reserve, and while there have been a few occasions where more “maverick” Chairmen have been a little “economic with the truth,” by and large what they say is what happens.

Jerome Powell may well be a “sheep in wolf’s clothing” being a card-carrying member of the Republican Party at a time when Congress is Democrat, but both President Biden and his colleagues at the Treasury Department have demonstrated faith in his handling of the economy, at least as far as monetary policy able to influence it.

Powell has been nothing but consistent in his guidance to the market, as he has demonstrated a level of data dependency that is backed by the way the economy has reacted to interest rates being at their highest level for close to twenty years.

His comments on monetary policy have only changed marginally since the FOMC voted to leave rates unchanged last August, as he has acknowledged that the rate of deflation has slowed to the extent that it appears to have stalled.

It may well be that the economy is now at a level that interest rates are no longer slowing demand and consumers have adapted to such an extent that a rate cut would see demand rise, driving inflation back to levels not seen in more than a year.

While the recent comments of Michelle Bowman were more hawkish than has been seen from a Fed Governor in quite some time, the interview with Minneapolis Fed President Neel Kashkari summed up the mood of Regional Fed Presidents more succinctly.

The FOMC currently does not need to rush into an interest rate cut given the current comparisons between growth and employment and its mandate.

Jobs growth remains strong, and the economy is predicted to grow at a rate of between 2% and 2.5% this year. There is no historical precedent for a rate cut to be agreed upon when the economy is performing as it is currently.

The threat of a hike in rates remains but, in Kashkari’s words, the FOMC needs to continue to show patience to allow the economy to adjust.

The timing of the first cut in rates is frustrating the market, but “deep down” it knows that the Fed will withstand any pressure to act in a manner which may be considered precipitate.

The dollar is gaining strength from the expectation that the Fed will be the last G7 member Central Bank to cut interest rates.

Yesterday, the dollar index rose to a high of 105.64 as traders digested the recent comments from FOMC members. It closed at 105.51 and remains on course to begin to accelerate its gains.

Most days ECB President Christine Lagarde makes a speech, or at least provides a “sound bite” in which she “teases” the market about when the first cut in interest rates will happen.

However, traders and investors are beginning to question if she speaks with the same level of authority as Jerome Powell or even Andrew Bailey.

Her supporters will point to the fact that the makeup of the ECB’s Governing Council makes it unwieldy and although it may well be preferable for the decision-making process to be scaled back, that is not how “things are done” in the Eurozone.

Nonetheless, some members of the Council have a “voice that is larger than their country’s contribution.” One such voice is that of Robert Holzmann, the Governor of the Austrian Central Bank. It may well be unkind to consider Austria to be “Germany lite” but Holzmann certainly challenges the Bundesbank President Joachim Nagel in terms of influence.

It may be a coincidence that as the German economy has weakened in the past eighteen months, Nagel has been considerably less vociferous than his predecessor, Jens Weidmann during his ten years in the role.

Yesterday, Holzmann spoke of his view that there is no reason for the European Central Bank to cut interest rates too fast or too strongly, adding much depended on the U.S. Federal Reserve.

Christine Lagarde is almost strident regarding the ECB’s ability to “go it alone.” Holzmann is far more pragmatic in his outlook, realizing that the markets are more interconnected than they have ever been and that the Euro will be certain to suffer if a rate cut takes place in June and this may well provide more impetus to inflation, even if it does stomp deflation falling below the Bank’s 2% target.

Holzmann went on to acknowledge that the ECB’s policy steps are influenced to a greater or lesser extent by the actions of the Federal Reserve.

The ECB has “pretensions” for the Euro to one day replace the dollar as the global reserve currency, but that day is no closer than it has been since the advent of the single currency.

Yesterday the euro lost ground despite Holzmann’s slightly hawkish comments, as the market is beginning to expect deeds, not words. The common currency fell to a low of 1.0735 and closed at 1.0748.

Have a great day!