19 February 2024: CPI Inflation is lower than predicted

Last week’s publication of inflation data for the UK was overshadowed by the news that the country had slipped into a recession. A closer inspection of the data showed that headline inflation fell by more than the market had expected.

Sterling surprisingly ended the week stronger, even though the pressure on the Bank of England to cut interest rates has intensified. The Chancellor was relaxed over the news that the Fourth quarter GDP fell by 0.3% after a 0.1% fall in the period between July and September.

He told reporters that his faith in the Monetary Policy Committee to make a “considered decision” about when to cut interest rates remains “unshaken.”

Two independent members of the MPC commented on their views about the economy and inflation on Friday.

Catherine Mann, the most hawkish member of the group, said that the news that the economy had fallen into recession had come as no surprise to her.

She told reporters on a visit to the U.S. that it was clear that the economy had hit a “soft patch” in the second half of the year, and “something had to give” considering the number of rate rises that had taken place.

Although she had moderated her hawkish tendencies since the last meeting, at which she voted for rates to be raised, she is still of the opinion that secondary inflation remains an issue.

She went on to say that last year’s GDP is now in the “rearview mirror,” and she prefers to look at “forward-looking data,” like this week’s purchasing managers reports.

Meanwhile, one of the Committee’s newest members, Megan Greene, who had sided with Mann in every meeting up until the most recent one, where she voted for no change, spoke of how the supply side of the economy is experiencing geopolitical issues, and they are contributing to the “stickiness” of inflation.

CPI was still twice the Bank of England’s target in both December and January, even though many British businesses had cut their margins. Greene believes that the supply constraints are unique to the UK.

Even though she didn’t mention Brexit, it was clear that was one of the issues she feels contributes, although she sees the situation easing in the coming months.

Despite its rally towards the end of the week, Sterling still lost ground over its previous weekly close. It fell to a low of 1.2535 and closed at 1.2600. Since the beginning of the year, it has traded in a narrow range versus the dollar as traders await solid evidence of any change in monetary policy.

The continued elevated level of interest rates is incongruous when considered through the lens of how equity markets have performed since the start of the year.

The current valuations reflect the market’s confidence that the FOMC will cut rates “sooner rather than later. There is a lot of “noise” coming from Wall Street, about the need for rates to be cut and that continued high rates will drive the economy into recession.

That expectation has been being expressed for more than a year. Every time month-end has been approaching, some predict that job creation is about to collapse, yet the numbers continue to defy gravity.

Jerome Powell would doubtless appreciate some moderation in the NFP data, particularly since the economy created almost 700k new jobs in the past two months alone.

Powell believes that the U.S. is on an unsustainable fiscal path, although Treasury Secretary, Janet Yellen, has spoken of her view that fiscal policy is justifiable.

This is not a view that is shared by likely Republican Presidential Candidate, Donald Trump.

Meanwhile, members of the FOMC have been airing their views about the timing of the first rate cut, with several being prepared to be “convinced by the data.”

San Francisco Fed President, Mary Daly, joined her colleague, Loretta Mester, the President of the Cleveland Fed in calling for patience from those demanding an immediate rate cut.

Daly commented the Federal Reserve needs more time and data to ensure inflation is truly subdued before cutting its key interest rate. This was in tune with Mester’s comment that with an uneven path lower for inflation and a strong economy, the Fed doesn’t have to be in a rush to trim rates.

The dollar index again made a higher close last week, to continue a run that began in the first week of January. It is making slow but steady progress. It reached a high of 104.97 last week and closed at 104.28.

Today, the market will observe Presidents’ Day. This means that liquidity may become a little thin later in the day, while later in the week preliminary data will be published for economic activity in February.

The ECB continues to talk a good game, making plans to review its policies “when the time is right.”

It performed a study regarding the introduction of a digital euro early last year, but so far, despite the number of cash machines shrinking at an alarming rate, no progress has been made.

There have been calls for the size of the Governing Council to be trimmed, with delegates working on a rota basis to simplify the decision-making process, while there are conversations taking place about the need for an executive board with undue influence, despite being unelected.

The “official” mandate of the Executive Board is to implement monetary policy for the euro area following the guidelines specified and decisions taken by the Governing Council.

The level of bureaucracy within the entire European Union appears to be almost designed to stifle the decision-making process and limit accountability.

The French Finance Minister announced that his country’s government had cut its growth forecast for this year to 1%. In the words of Bruno la Maire, this is due to the headwinds that the country currently faces.

He went on to announce a fiscal savings plan that would reduce public spending by ten billion euros, reflecting a broader commitment to fiscal prudence and resilience.

Any further cuts to public services may bring the usually militant French “man in the street” out in protest.

La Maire’s comments at least show a level of fiscal responsibility that has been lacking in several other Eurozone members over the past year, as the Growth and Stability pact appears to have been entirely forgotten.

This is yet another item of “housekeeping” that the ECB has allowed to be “kicked into the long grass.”

The European Commission also reduced its forecast for GDP this year to 0.8% from 1.1%. This reflects the continued prohibitive cost of borrowing.

The Commission also expects inflation to halve this year to 2.7%, still above the ECB’’s target of 2%. It remains to be seen if that forecast will have any effect on the voting intentions of the Governing Council.

The Euro is “serving two masters” currently. On the one hand, continued high-interest rates are providing a degree of support, while the outlook for the economy is supporting the market’s bearish tendencies.

Last week, the single currency fell to a low of 1.0694, but it recovered to close at 1.0776.

Have a great day!