21 May 2024: Has the economy reached a tipping point?

If the Conservative Party were to win the upcoming General Election, it would rank among the greatest turnarounds in political history.

It is implausible, but the Labour Party is becoming jittery as the economy appears to be going from strength to strength, despite their strong showing in the recent council elections and Parliamentary by-election.

Labour is beginning to believe that the election will be fought on the “battleground” of the economy and, while Rishi Sunak and Jeremy Hunt continue to promote “sticking to the plan”, Keir Starmer and Rachel Reeves fear an “emperor’s new clothes moment”.

Labour still holds a significant lead in the polls, but there is doubtless a nagging doubt in the minds of their MPs of the mammoth task it would require for it to not only turn around an eighty-seat majority but then achieve a majority of its own.

It may be that the country is headed for a series of elections, as it is eminently possible that the election that will be likely to be held in the autumn will deliver a hung Parliament.

At least a return to political issues will provide a break from the constant consideration of when the first cut in interest rates will take place.

Speaking of which, the Monetary Policy Committee saw yet another of its permanent members speculating about a rate cut yesterday,

Ben Broadbent, the Deputy Governor for Monetary Policy, is the one member of the Committee whose role is to keep his “finger on the pulse” of the economy and is best placed to comment on interest rates.

Yesterday he took up the subject of MPC member’s previous voting records, commenting that Whatever the priors of its members the MPC will continue to learn from the incoming data and, if things continue to evolve with its forecasts that suggest policy will have to become less restrictive at some point, then it’s possible the bank rate could be cut sometime over the summer.

Although his comments lack a definitive edge, he at least provided some degree of certainty that the MPC is moving away from groupthink and expressing its own opinions.

Broadbent’s colleague, Huw Pill, the Bank’s Chief Economist, “teased” the market in a speech last week in which he said that a summer rate cut is still possible, but there is still more work to be done to get inflation down.

The pound may be running out of steam following its recent rally, with yesterday’s gains appearing exhaustive. It climbed to its highest level since mid-March, reaching 1.2717, but fell back to close at 1.2706.

It is fast becoming a fact that the FOMC cannot “shock” the markets in the way it used to, which has often been one of its major weapons.

The adage that “the Fed always wins” seems to no longer apply, and for this reason, tomorrow’s publication of the minutes of the latest meeting of the rate-setting group is already being treated as a damp squib.

Several members of the committee have spoken recently of their “concern” that the pace of deflation has slowed, almost to a standstill, and a rate cut may have to be delayed.

Gone is the definitive guidance where members of the FOMC would provide the market with direction on what needs to take place for a change in monetary policy to happen.

It seems that the Committee has been overtaken by a policy of “wait and see” which is pushing the market to make interpretations which may be either incorrect or unwarranted.

A good example of this is the news story which appeared yesterday that Fed Chair, Jerome Powell, wants to be able to cut rates in September. This is a highly speculative interpretation of his recent comments and could easily have been interpreted as him not wanting to cut rates until much later in the year, if at all.

Powell provides his opinions based on the economic data, as he has said many times, and not using a preconceived timetable.

Since there is no definitive advance guidance being provided, market commentators are presenting their interpretations, often inferring that they are facts.

The FOMC is becoming almost factional in its comments. Raphael Bostick, the President of the Atlanta Fed. appears to want to move any thought of a cut in interest rates, close to the end of the year.

In fact, in a speech he made yesterday, he floated the idea of the fight against inflation continuing into 2025.

That is by far the most hawkish statement made by any member of the FOMC since rates were placed on hold. He then qualified his statement by saying that he is “open to all possibilities” on the path of the economy. In effect, he is leaving speculation up to the market.

The dollar will begin to gain as the possibility of a summer rate cut fades, particularly if the ECB “goes it alone”.

Yesterday, the dollar index appeared to be forming a base around 104.20. It rallied to a high of 104.65 and closed at 105.62.

In the past, the thought of the Governor of the Latvian Central Bank making comments about future monetary policy would have been a matter for the final column of market commentary about the Eurozone.

Now, given the turnaround in the fortunes of the “peripheral” nations, such comments are no longer considered the “tail wagging the dog”.

Although the “heavy hitters” like Isabel Schnabel are still listened to by the market, Governors of smaller nations’ Central Banks not only have pertinent opinions but those opinions are being given credence.

Martins Kazaks, spoke yesterday of his view that although a rate cut next month is a “done deal”, the idea that it should be the first in a series of cuts should be considered carefully.

Agreeing with Schnabel that the most recent data doesn’t support any further cuts currently. Underlying this opinion may well be a concern that if the ECB “goes it alone”, the consequent fall in the value of the Euro may see the fall in inflation “stopped in its tracks”.

Kazaks went further than Schnabel by suggesting that any future cuts should match the fall in inflation. This allows for a short-term rise in inflation caused by currency weakness.

Kazaks believes that a data-dependent approach has been an appropriate one so far.

Forward guidance is still not a good policy solution given the current elevated level of uncertainty, the baseline scenario, inflation is gradually approaching the 2% inflation target.

A report from the European Commission provided some hope to those who still see the June rate cut as the first in a series. The EU commented that the impact of Red Sea trade disruption will be milder than expected. While this is the current situation, the region is still highly volatile and could flare up at any time.

The euro lost ground yesterday as the market is becoming more convinced that a rate cut will happen on June 6th.

Yesterday, the common currency fell to a low of 1.0854 and closed at 1.0857.

Have a great day!