17 November 2023: Pill’s comments demonstrate MPC uncertainty

The Bank of England’s Deputy Governor for markets and banking, and Chief Economist, spoke yesterday of their views on the short-term path for interest rates.

Dave Ramsden, who was recently re-appointed for a second term as a member of the Monetary Policy Committee, believes that interest rates will need to remain elevated for an extended period.

His colleague, Huw Pill, who recently agreed with the market’s view of when the first cut in interest rates will take place, spoke of inflation remaining “sticky” and the possibility that rates may need to rise again in the short term before the longer-term path lower begins.

Both voted for rates to remain on hold at the most recent MPC meeting.

Ramsden’s comments followed the recent rhetoric that permanent members have adopted, while Pill appears to be more “fluid” in his opinions, reacting to the situation as it changes.

It is impractical, given the time it takes for changes in monetary policy to feed through into the economy, for a need for higher rates to be identified one month only to be followed very shortly afterwards by a situation that demands a cut.

The Bank has been accused by several observers of muddled thinking recently as rates have approached a level at which they are becoming restrictive upon demand. Bank of England Governor, Andrew Bailey, has been blamed for not having the courage to decide on a course of action and sticking to it, which has led to some degree of uncertainty.

His recent comments have shown that he feels unable to declare the end of rate cuts, and other permanent members of the MPC feel unable to contradict his comments.

Ramsden, who handles the Bank’s programme of quantitative tightening, freely admits that it is uncertain what the optimum size of its balance sheet will be once it has sold the agreed number of its stockpile of bonds.

The size of the Central Bank’s balance sheet is another method of controlling the level of liquidity in the market. The Bank of England was the first among G7 Central Banks to actively start selling down its stockpile of bonds that it began during the financial crisis of 2008.

It is committed to reducing its bond holdings by £100 billion between last month and next September.

The Pound continues to be driven by the markets view on changes to monetary policy while the economy adjusts to their effect.

Yesterday, traders were looking to re-establish short positions, but Pill’s comments about possible further tightening deterred them.

Sterling ended the day virtually unchanged on the day at 1.2408.

It is still unlikely that the FOMC will actually “grasp the nettle” and declare its cycle of interest rate increases to be at an end.

Although the Fed says that it is both data driven and trend-following, Jerome Powell, the Chairman of the FOMC, is sufficiently concerned about inflation returning that he believes it would be misleading for victory to be declared.

He has been backed up by several members of the committee recently, despite the evidence being relatively clear that the economy is headed for the fabled soft-landing.

The most recent data shows that the employment market is cooling as rates are either at or very close to the level at which they become restrictive upon economic activity, having entered a neutral phase, where they are neither accommodative nor restrictive in the Summer.

The fall in inflation was predictable, given the way energy prices have fallen, but Powell is still adopting a hawkish tone, seemingly unable to believe that his policies have been successful.

With the next meeting of the FOMC not taking place until December 13th, there will be plenty of time for its members to have access to a full suite of economic data for November.

There is little reason to believe that the employment figures will do anything other than continue to fall, although the cooling that took place in October followed a significant rise in the number of new jobs created in September.

It may still be too soon, dependent on the November data, for the Fed to consider that a trend lower has begun.

Powell has already said that the path lower in inflation won’t be linear, so it will be difficult to predict where inflation will be this month, while retail sales and consumer confidence continue to moderate.

Another pause is the market’s base case for the outcome of December’s meeting, which will see three pauses in a row and encourage market speculation about the timing of the first cut in rates.

Again, if the unemployment rate rises above 4% and average earnings continue to fall, a cut may take place late in the first quarter of next year. However, if inflation stays in its current range, a cut may not happen until late in the second quarter.

The dollar’s recent price action shows the market’s uncertainty. The dollar index appears to have “bottomed out” following its fall earlier in the week, but its recovery is still uncertain.

Yesterday, the index “trod water”, ending the day unchanged at 104.38 having earlier fallen to test the support at the bottom of its range this week.

While the ECB is the only G7 Central Bank to have declared that interest rates are sufficiently restrictive to allow it to end its cycle of interest rate hikes, there is a feeling in the market that it was perhaps a little premature to say that rates will remain at their current level for a “considerable” period of time.

There have been several reports published recently that predict that the Eurozone economy will fall into recession either by the end of this year or during the first quarter of 2024.

It may be that the region will escape having to declare a “technical” recession at the end of next month as there is a possibility that the economy will flatline, but there is little doubt that by just about every measure the economy is in a recession already.

Christine Lagarde will make a speech today in which she is expected to reiterate her view that rates will be unchanged for the foreseeable future, although she may be less forthright than she has been recently.

Her colleague, Robert Holzmann, leader of the Austrian Central Bank and the most hawkish member of the Governing Council, will also speak later.

Holzmann has been very vocal about his disagreement with the decision to halt the programme of interest rate hikes, with inflation still a long way for the ECB’s target of 2%.

Lagarde is also likely to enter a discussion which has been exercising the Eurozone’s regulators for several months. The question of the treatment of losses incurred by banks on bond holdings at the time of the collapse of Credit Suisse.

EU banks face significant losses should the bonds they are holding have to be sold. She has already told the European Systemic Risk Board, which she chairs, of her concerns.

Banks are already struggling for profitability given their increased funding costs as well as an increase in bad and doubtful loans.

There is a great deal of work for the European Commission to do to avoid systemic risks in the Union, which have been worsened by increasing inflation and the recent downturn in economic activity.

The euro tried to break the 1.09 level yesterday, but only reached 1.0895 before it ran into significant selling interest. It ended the day in common with other major currencies, unchanged at 1.0846.

Have a great day!