18 December 2023: Bank of England maintains stance

Following the latest meeting of the Monetary Policy Committee, the Bank of England Governor, Andrew Bailey, reaffirmed the Bank’s commitment to lowering inflation closer to the Government’s 2% target.

The latest employment data showed that wages are still rising at a faster rate than inflation, which is a major concern for the MPC and is likely to deter any discussion about cuts in rates for some time.

With the economy barely registering any growth over the past two quarters and headline inflation still close to 5% the outcome of the next few meetings of the MPC will be on a knife edge.

The element of “groupthink” that has been evident at recent meetings, where permanent members all vote in the same way, has led to its decision-making process being distilled down to the opinion of one man.

Bailey has been confusing markets recently by, on the one hand, saying that it is far too early for rate cuts to be discussed, then, on the other, commenting that the conditions for growth are currently the worst he has seen in his entire career.

Last week’s meetings of the three major G7 Central Banks showed that after several meetings where they all expressed their commitment to lowering inflation, they are diverging as the equilibrium of their economies becomes more balanced.

For the Bank of England, a recession has never been far away, even as rates were being continually raised. The most recent data shows no change in that scenario. The start of the fourth quarter saw the economy shrink by 0.3% in October, and PMIs all show output contracting.

There has been good news for headline inflation, as the forecourt price of Petrol and diesel has fallen to its lowest price for more than two years. The average price for petrol now stands at 141p a litre.

With inflation continuing to fall, partly due to lower energy costs and in part due to the continuing legacy effect of rate hikes, the Bank’s commitment to keeping rates higher for longer will be tested in the New Year.

With market expectations for the first cut having moved from August to June, it will be tough for Bailey to wait until the economy posts the requisite two quarters of negative growth before rates are cut.

The pound reacted to the Fed Chairman’s acceptance of the fact that rate hikes in the U.S. have come to an end and that cuts in the fed funds rate were discussed at the latest FOMC meeting.

Sterling climbed to a high of 1.2794 as several short positions saw their stop losses triggered. This was quickly seen as a knee-jerk reaction, and the pound retreated back into its recent range, closing at 1.2673.

The next two weeks are unlikely to see any significant moves for major currencies as the market lacks any fresh drivers and the end of the year approaches.

The goldilocks scenario where the economy is seeing moderate job creation and falling inflation is fast becoming a reality in the U.S. economy.

While the Fed has studiously avoided any mention of a soft landing for the economy following a sustained period of rate hikes, members of the Administration have been far from coy.

Janet Yellen has recently made several comments in which she made it clear that she expects a soft landing to occur in the next few months, while President Biden risked ridicule by expressing a number of months ago his confidence that the Fed would deliver on his promise that inflation would fall back close to the 2% target without any significant job losses.

The employment market has remained buoyant, leading to a view among several economists that rates are still in neutral territory and inflation has not been defeated.

That is the likely reason why the FOMC and its Chairman in particular didn’t feel comfortable in commenting publicly that the cycle of rate hikes had come to an end. The fact that someone as conservative as Jerome Powell was able to say that the cycle had, most likely, come to an end should receive a lot of credence.

Early predictions for the employment market in 2024 are that there will be some job losses and even some months when the headline NFP number is negative, but if growth remains in the ballpark it finds itself currently, the economy should enter the period leading up to the Presidential Election with a positive outlook.

Powell’s comments following the FOMC meeting, where he delivered a “double whammy” of confirming that rate hikes are at an end and rate cuts are being discussed, saw the Dow Jones Index close above 37,000 for the first time, although they also saw the dollar nosedive to its lowest level since August.

The dollar index fell to a low of 101.76 although some “bottom feeders” saw the fall as an opportunity to re-establish long positions in expectation of the arrival of the soft landing and the index recovered a little to close at 102.60.

This week will see the second cut of Q3 GDP published. It is expected to show that the economy grew by 5.2% between July and September, which should encourage the dollar to resume its climb.

It is one thing for industrial and consumer confidence to grow. but quite another for indicators of output and demand to remain in the doldrums.

It may very well be that the data for confidence in the Eurozone economy that was published last week was a reaction to the fact that it has possibly fallen as low as it could and will remain close to recessionary levels until the ECB feels able to loosen monetary policy.

With inflation falling at a faster rate than the ECB predicted, the Central Bank still feels unable to see any reason to cut rates for the first two quarters of next year as it continues to promote a “belt and braces” attitude where rates will remain high, and its balance sheet continues to be reduced in size.

This is in no small part due to the way fiscal policy is being used in a few member states to negate the worst effects of tight monetary policy.

In Italy, for example, if the “man in the street” has more money in his pocket at the end of the week, he is not massively concerned if that is because his credit card rates have fallen or if he is paying less tax.

In her speech following last week’s meeting of the ECB’s Governing Council, Christine Lagarde confirmed that she cannot see any rate hikes on the horizon despite the fact that she felt comfortable to reduce the Bank’s inflation forecast.

Following recent comments about the Pandemic Emergency Purchase Plan (PEPP), not only was this discussed, but Lagarde announced that it will be cut by Eur 7.5 billion per month but not starting until the second half of next year.

Lagarde confirmed that in the Council’s view, the programme of rate cuts that ended recently has given the Bank an opportunity to “wield a great deal of influence over the economy that hadn’t previously existed”.

It seems that they are not in any hurry to reduce that influence by cutting rates.

The euro benefitted from the clear difference in the attitude to rate cuts between the FOMC and ECB. The single currency rallied to a high of 1.1009, but quickly ran into significant selling pressure and retreated to close at 1.0894.

Today, Isabel Schnable and Philip Lane are scheduled to make speeches, and it will be interesting to note if their views are beginning to converge as inflation continues to fall.

Inflation data is due for release tomorrow, even if it sees a significant fall, the ECB has already confirmed that it is unlikely to be moved.

Have a great day!