15 September 2023: Rate setters split over next move

The prospect of another hike in interest rates has become more likely following the data that has been released this week.

Although unemployment has begun to rise which is an indicator that the Bank of England’s continual tightening of monetary policy over the past 20 months is beginning to restrict demand, average wages are now at the same level as inflation and showing no sign of falling.

This will add to inflation as employers are forced to raise their prices to cover their costs. Most worrying has been the increase in wages in the service sector of the economy which had so far managed to avoid a wage/price spiral.

Average earnings in the three months to July rose by 8.5% and are now higher than the headline rate of inflation. It is expected that as inflation falls, wages demand will begin to abate, but there is always a lag in the timing of the two which means that the Bank of England may be forced to act.

Next week’s MPC meeting is now almost certain to raise the base rate of interest to 5.50% which will be a blow to homeowners who were hoping to see a fall in mortgage rates but will now probably be forced to pay more for flowing rate loans.

Although the permanent members of the MPC hold the “whip hand” in deciding a further rate hike, it is the independent members who have made the most serious attempts to explain what will influence their vote.

Catherine Mann remains a hawk over interest rates, calling this week for the Bank to be prepared to “overshoot” hikes and be prepared to introduce rate cuts if that is proven to have happened. She is concerned that a high rate of inflation will become ingrained in the UK economy and must be guarded against.

Swati Dhingra, however, believes that interest rates are high enough to be restrictive on demand and the Bank is running the risk of driving the economy into a damaging recession.

Of the two, events this week appear to favour the opinion of Dhingra, but the ever-cautious attitude of Andrew Bailey is likely to come down in favour of a further hike.

Since rates are still at a point where they are neutral, neither encouraging nor restricting demand, a lot will depend on the comments made following the decision to determine the short-term path for Sterling.

With the ECB hiking yesterday and the MPC and FOMC meeting next week, the entire monetary policy for G7 economies will become clearer and the market will begin to concentrate on relative growth rates.

Yesterday, the pound followed the Euro in losing ground to the dollar. It fell to a low of 1.2398 and closed at 1.2408 as its rate of descent appears to be accelerating.

After the ECB disappointed the traders and investors by agreeing a further hike in short term interest rates yesterday, the focus will now switch to the FMC which will announce its own decision on monetary policy on Wednesday evening.

For some considerable time, Central Bankers have professed to be data dependent. If this is true of the FOMC then a rate hike following next week’s meeting of the FOMC is certain.

Although a rise in the headline rate of inflation was expected given the rise in gasoline prices, is exceeded expectations, and while there has been a degree of cooling off in the number of new jobs being created, having tried to dampen demand by raising interests rate for several meetings, the NFP data is still too high of this stage in the cycle.

The market has decided that being data driven is a catch-all comment designed to allow the Central Bankers more time to consider their decision. It is not an easy phrase to disagree with and encompasses the role of the various rate setting committees, even if they do not genuinely believe it themselves.

While the possibility of a soft landing for the economy still exists, even as the Treasury Secretary believes it could happen, there are still nagging doubts in the minds of economists that the Fed may not be able to buck the trends that are still pointing to a recession.

The market is gaining confidence in the fact that Jerome Powell appears equipped to deal with a slowdown in the economy despite his outwardly hawkish comments.

Powell is not given to throwaway comments and even his ad lib lines are well rehearsed, which is a product of time spent in courtrooms.

The prospects of another hike or a pause at next week’s meeting are now more evenly balanced, although traders still feel that a pause can be more easily rectified if inflation continues to rise than a hike.

The dollar index has moved into another level having broken through a line of resistance yesterday. It is now targeting 105.62 which is its high for the year so far.

It reached a high of 105.43 yesterday and closed at 105.34.

A hawkish hike was not near the top of anyone’s list of predictions for the outcome of yesterday’s meeting of the Governing Council of the ECB, but that after weeks of speculation is what Christine Lagarde delivered.

A twenty-five-basis point hike, to bring rates to a record high of 4.50 was never considered to be out of the question, but what followed was a surprise.

The ECB President resumed her hawkish position, gauging the mood of the meeting in refusing to rule out further hikes.

In her statement following the decision, Lagarde acknowledged that some members wanted to pause, but the majority voted for another hike. Although she refused to rule out another hike, she did acknowledge that rates have now “reached a very limiting state and will be enough to control inflation.

She then slipped into the language of all Central Bankers to insist that the Governing Council remains data driven.

Former ECB Chief Economist Peter Praet spoke yesterday of his belief that the Central Bank was right to decide to hike again and said that he feels that an inflection point has been reached.

Praet believes that the economy is set to enter a period of stagflation, where there is little or no growth in which inflation continues to rise or falls at a slow pace.

A terminal rate has come closer after yesterday’s decision where the hawks clearly remained in the ascendancy.

Over the next week or so there are likely to be extremely critical comments from Italy since they already believed that rates were too high and are driving the Italian economy into recession.

It remains to be seen if the data supports a rate hike since in the period leading up to yesterday, that had hardly been the case, although average wages have been rising for a few months now.

The Euro took the hike badly with the market looking to comparative future growth prospects.

The common currency fell to a low of 1.0631 and closed at 1.0643. It is now threatening the area of congestion that it saw in March, and any further weakness could see it make a new low for the year.

Have a great day!