20 December 2023: Wage growth is still too high


  • MPC member says that rates will have to remain high
  • Higher for longer may support the dollar in 2024
  • No change in message before March. No cut before June
GBP – Market Commentary

MPC pinning its hopes on legacy action

The latest new addition to the Monetary Policy Committee, Sarah Breedon, made her first public speech yesterday, and quickly settled into her role of “toeing the party line”.

Breedon warned that rates will need to remain higher for an extended period to bring down wage growth that is still running at over 7%.

She commented that the current level of wages growth is several percentage points from where it needs to be for inflation to fall close to the Bank of England’s target of 2%.

In a speech which could have been made by any one of her permanent colleagues on the MPC, Breedon trotted out several of the standard phrases that have become synonymous with the role over the past year.

“Too early to claim victory over inflation, the Committee remains driven by the data, and the market’s view of when rate cuts will happen differs from our own,” have become standard.

The MPC is relying on “secondary effects” of earlier rate increases to work their way through the economy and check inflation, but this is unlikely to happen unless wage settlements fall back into line.

Should inflation continue to fall at its current rate, interest rates are expected to fall to around 4% by the end of this year and continue to fall, reaching a low of 3% by the end of 2025.

This, of course, relies on there being no unexpected events in the coming months/years. Furthermore, the effect of next year’s General Election and the new policies that come with the probable election of a Socialist Government will doubtless have an effect.

The likelihood of a yes vote in any Scottish referendum on independence has gone from probable to possible, as the country continues to reel from a Government that seems more rooted in Westminster than Holyrood.

This is driven by the sobering thought that by any measure the Scottish economy is too weak to have any application to rejoin the EU, post-referendum, rejected.

The pound gained yesterday, continuing to be driven by the view that the market appears to have adopted, that the Fed will be the first G7 Central Bank to cut rates. This view is born out of Jerome Powell having finally accepted that the cycle of rate hikes is at an end.

Sterling climbed to a high of 1.2764 and closed at 1.2724 in thin threading conditions.

USD – Market Commentary

No cuts expected while inflation remains “elevated”

Despite its recent correction, the dollar is expected to arrive in the New Year on the front foot, or at least in a condition which will provide the foundations for a strong first half to 2024.

Despite the Fed ending its cycle of interest rate hikes and the stock markets reaching all-time highs, there is a curious lack of consumer confidence, most likely driven by stubbornly high inflation.

As in the UK, the Fed is still relying largely upon the continued effect of past rate hikes to slow demand.

There is a growing split between fund managers who are having an unexpectedly bumper end to the year as the Dow Jones Index reacts very positively to the end to rate hikes.

Those who support the “higher for longer” side are being caught, and in several instances, overtaken by those who see the Fed being able to cut rates as soon as the second quarter.

The annual game of predicting as many pieces of economic data as possible has begun.

Inflation is expected to fall to a low of 3% over the next two years, with interest rates falling to 3.75 despite many models not expecting cuts in the first half of the year.

Employment is still considered difficult to predict. The current expectation is that the average headline new jobs figure next year will be between 75k and 125k, although several commentators see it as lower.

No econometric model can react to unexpected events built-in, and with the prevalence of such incidents over the past two or three years the predictions are little more than a “rule of thumb”.

So far, the potential mayhem associated with former President Trump gaining the Republican nomination has not been factored into the predictions.

This week, the Colorado Supreme Court deemed Trump to be ineligible to appear on 2024 ballots, due to his attempted insurrection, which is sure to test the resolve of his supporters in the State.

The dollar index renewed its fall yesterday as the market, even lacking in the usual level of liquidity, decided that any potential for rate cuts is more significant than the arrival of a soft landing for the economy.

The index fell to a low of 102.06 and closed at 106.11

EUR – Market Commentary

The Slovenia Central Bank head believes that the market has gotten ahead of itself

The Governor of the Central Bank of Slovenia spoke yesterday of his belief that the market is in danger of getting ahead of itself by predicting that the ECB will be able to start interest rate cuts as soon as early in the second quarter of the New Year.

Boštjan Vasle used a line from Jerome Powell’s lexicon yesterday by saying that the fall in inflation cannot be expected to be linear, given the number of moving parts that make up the data.

With the Fed signalling that rate cuts are being considered, following its meeting last week, the market is pressuring the ECB to follow suit, but so far it is presenting a united front in resisting the calls.

Vasle determinedly pushed back against calls for rate cuts, commenting that financing conditions may no longer be restrictive enough, given recent moves in Government bond markets.

He went on to say that the market’s expectation for the start of rate cuts and the totality of the cuts bear no relation to current reality.

The ECB will study data published between now and its March meeting, and then decide the best course for interest rates.

Current market expectations are inconsistent with the stance appropriate to lower inflation and keep it low.

It seems that at its most recent meeting, the Governing Council came to an agreement that the subject won’t be considered again for two meetings, which will allow rate hikes to have been fully absorbed into the economy.

The market is currently pricing in a 100% certainty of a rate cut in April, with two further cuts by June.

Vasle disagrees, believing that the ECB wants to see the complete picture for the first quarter before considering any adjustment to its stance.

The euro resumed its rally yesterday but is still unable to break through selling interest, which has now been lowered to around 1.0980. It reached a high of 1.0987 and closed at 1.0978.

In early Asian trading, it has again been unable to break that level and is currently (0500 GMT) trading at 1.0965.

Have a great day!

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Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.