24 October 2025: The 2% target may be the problem

One of the MPC’s most dovish members, Swati Dhingra, believes that the imposition of tariffs on UK exports to the U.S. may weigh on the economy and create the risk of a recession. The disruption to trade from tariffs "means lower overall growth, and some downward pressure on prices in the medium term," she added.

Dhingra, who has voted for a faster pace of BoE rate cuts, also said excessively high interest rates could cause longer-term inflation problems by limiting investment in new production capacity and improvements in productivity.

Last Saturday, BoE Governor Andrew Bailey told a meeting of financiers and policymakers in Washington that Brexit is continuing to hurt the British economy.

Dhingra cited research published earlier this year, which showed that services sectors most exposed to Brexit barriers had seen a 16% fall in exports to the European Union, which were not being made up elsewhere.

Brexit has demonstrated the corrosive effect of policy uncertainty on trade, productivity, and business investment," she said. Other research by economists pointed to GDP being 6%-8% lower, investment down 12%-18%, and employment and productivity down 3%-4% compared with staying in the EU, she added.

The Office for Budget Responsibility estimates that Brexit will reduce Britain's long-term level of productivity by 4% compared with remaining in the EU.

The Central Banks of three of the major members of the G7, the Federal Reserve, Bank of England and the European Central Banks all have the same target for inflation: 2%. While this may be a coincidence, it has become a millstone around rate-setters' necks and has no real place in monetary policy decision-making.

A target for inflation is not an “either-or” matter. The ECB’s sole point of reference is maintaining inflation at or very close to target, while the Fed has a dual mandate of maintaining maximum employment and stable prices. There is no mention of a target.

The Bank of England’s implicit mandate is to ensure economic stability by maintaining price stability and financial stability, regulating major financial firms and ensuring the resilience of the financial system. Subject to price stability, it also supports the government's economic policies for growth and employment.

In the minutes of the MPC meetings, no one ever appears to query the slavish attachment to the 2% target. It may be better to have a more abstract vision in which the bank tries to balance the inflation risk against the risks to growth from changes in monetary policy.

Alternatively, maybe a target of growth should be considered, which does away with a predetermined target for inflation.

The newspapers are reporting this morning that the Chancellor is considering a 1p rise in the rate of income tax in what would be the most significant betrayal of the Labour Party manifesto. Yet again, the leak has been carefully engineered by the Treasury to gauge public opinion.

However, if such a rise were confirmed, it would threaten the credibility of the government since there would be no guarantee that the additional income would be used to improve public services or cut NHS waiting lists.

The pound has had a fairly uninspiring week, losing ground at every session since last Thursday. Yesterday it fell to a low of 1.3308 and closed at 1.3326.

The Federal Open Market Committee is expected to consider lowering its benchmark interest rate next week, with the Bureau of Labor Statistics set to release September’s Consumer Price Index (CPI) later today.

Originally scheduled for the 15th, the release was delayed by nine days due to the Federal Government shutdown. The shutdown has caused consecutive disruptions in major economic indicators, making the CPI data the de facto sole metric available ahead of the FOMC meeting.

It is likely that several regional Feds have conducted their own surveys of employment and compared them to the “national” data published monthly by the Bureau of Labor Statistics in order to gauge what is happening in the market, although these surveys have not been published.

According to financial data provider FactSet, September’s CPI is projected to rise 3.1% year-on-year. Core CPI, which excludes volatile food and energy prices, is also expected to increase 3.1% year-on-year.

If the September CPI aligns with market expectations, analysts widely anticipate a twenty-five basis point reduction in the benchmark rate at this month’s FOMC meeting. This outlook is bolstered by Federal Reserve Chair Jerome Powell’s recent concerns over a slowing labour market and his indication that quantitative tightening (QT) could end within months.

The University of Michigan will also publish two surveys today, which will have an effect on FONC voting.

Consumer sentiments are expected to remain unchanged at 55. This will reflect the more relaxed attitude of consumers to the likely effect of tariffs, while the UoM one-year inflation expectations will be at 4.6% which is significantly higher than the Fed’s target. This may cause the more hawkish members of the committee to consider how they will vote next week.

Federal Reserve Vice Chair for Supervision Michelle Bowman stuck to her guns about cutting interest rates earlier this week, saying she hadn’t changed her opinion after dissenting from the rest of the Fed board in July about the need for a rate cut.

“The story is out there and that’s that. I haven’t changed my views,” she told Bloomberg News.

Bowman, along with fellow Federal Open Market Committee member Christopher Waller, became the first pair of Fed governors in 30 years to dissent jointly from the majority opinion after the committee voted in July to keep interest rates steady at a range of 4.25% to 4.5%.

The dissents followed a massive pressure campaign from the White House over the past several months to lower interest rates that saw Fed board of governors member Adriana Kugler step down from her position earlier this month.

President Trump replaced her with White House Council of Economic Advisers Chair Stephen Miran, who many analysts believe will be more receptive to Trump’s calls for lower rates and to his views on monetary policy in general.

The dollar index continues to advance in baby steps. Yesterday it rallied to a high of 99.14, but there appear to be some legacy sell orders above the old 99 resistance level which are standing in the way of the dollar's advance. The execution of these orders drove the index back to close at 98.94.

One of Angela Merkel's chief aids told reporters yesterday that he believes that it is time for a German to fill the role of President of the European Central Bank.

So far, a Dutchman, a Frenchman and an Italian have held the role with varying degrees of success.

“I think it would be time, but it’s complicated,” Lars-Hendrik Roeller told Bloomberg Television yesterday at the Berlin Global Dialogue. “It’s usually also a package deal with other jobs. I think the other big jobs in Europe are not on the line.”

The ECB is heading into a two-year shake-up that will replace two-thirds of its top leadership. The process will kick off with finding a successor for Vice President Luis de Guindos, whose term finishes in May 2026. Next up is the position of chief economist a year later, followed by Lagarde’s job in October 2027.

When asked about potential candidates, Roeller, who founded and now chairs the Berlin Global Dialogue, said “I like our ex finance minister Jörg Kukies.”

“I think he’s a good person, but there would be others,” he said. “I think it’s more important to get a good person.”

What may speak against Germany are the other top European jobs it currently holds, most notably Ursula von der Leyen’s presidency of the Commission through 2029, though there’s also Claudia Buch’s leadership of the ECB’s Supervisory Board.

Europe’s top banking regulator should be given a mandate to ensure the continent’s banks aren’t just safe but can also stay competitive, according to Deutsche Bank’s Chief Executive Officer Christian Sewing.

The European Central Bank should move beyond its focus on financial stability and include considerations of competitiveness when regulating banks, Sewing said at a conference in Frankfurt. In doing so, the watchdog should follow the example of the US Federal Reserve and the Bank of England, which already pursue such a goal, he said.

It is clear that there is a requirement for the update of several European Institutions in the coming months and years, as the union should no longer be considered a fledgling group, despite its obvious fragilities.

Christine Lagarde and Joachim Nagel have both called for a centralised equity market this week, which would go a long way to solidifying investment possibilities, although, given its past decision-making, it may take years to agree on a location for the new bourse.

Next week will see the Central Banks of the U.S. and Eurozone meet to agree on monetary policy. UBS believes that a Fed rate cut is a “done deal”, while the ECB has made it eminently clear that rates will not be changed, as several of its officials have talked of their satisfaction with the current levels of growth and inflation.

The Euro remains in the doldrums, even though there are plenty of reasons for there to be increased volatility. President Trump’s decision to increase sanctions on Russian oil experts may also affect European imports, while the tariff issue lurks in the background.

The single currency made a high of 1.1620 yesterday and closed just two pips lower, although there is little current interest to but hold positions ahead of next week's Central Bank meetings.

Have a great day!