26 February 2024: A rate cut in March is “very likely”

The Bank of England appears to have performed a pivot following the news that the economy dipped into recession in the fourth quarter of 2023.

When apportioning blame for the contraction, the media has decided that the fault lies with the Government. However, it is unclear what could have been done differently given the geopolitical situation. In contrast, the Bank was quick to react to the rise in inflation, hiking rates in December 2022 although the “drip feed” of twenty-five point increments “prolonger the agony”.

Now, with inflation falling and likely to fall further given the regulator’s reduction of the price cap from £1,920 to £1,698 in April, Andrew Bailey and his colleagues who constitute the permanent members of the have given the market reason to believe that rates will be cut sooner than was previously expected.

The Spring Budget will be delivered by the Chancellor, Jeremy Hunt, in a couple of weeks and there is speculation that he is mulling over more significant cuts in taxes than he was considering. The Public Sector Borrowing Requirement fell to £5.5 Billion from £7.1 Billion a year ago, which may provide Hunt with more “wiggle room”.

It is unclear if Hunt and Rishi Sunak have agreed to deviate from “the plan.” Cutting tax would be more in line with Conservative Party values than the increases that have been agreed since the reversal of Liz Truss’s “Budget for growth” that almost wrecked the economy.

Many economists believe that tax cuts are a more “immediate” remedy for the economic slowdown that has been taking place for the past eighteen months.

A cut in corporation tax would make the UK more competitive and provide a greater incentive to firms to invest in the country while cutting the basic rate of income tax and lowering National Insurance contributions would provide households which have been struggling with a rising cost of living with some relief.

The Budget is likely to be Hunt’s last chance to make a significant contribution to his Party’s election preparations, although there is still speculation that Sunak may wait until close to the end of the year to call a General Election.

This week, there are no tier-one data releases. Sterling will likely be driven by Central Bankers’ comments.

Huw Pill, the Bank of England’s Chief Economist, will deliver a speech later this morning, while David Ramsden will provide further insights tomorrow.

The pound has remained in a narrow range since the start of the year, rarely deviating outside a 1.2520 to 1.2720 range. This unusual run will most likely only be broken when either the Bank of England or the Federal Reserve loosens monetary policy.

Last week, Sterling reached a high of 1.2709, but lost momentum and closed at 1.2660.

There is no need for the Federal Reserve to rush into cutting interest rates while the core rate of inflation remains “stuck” at around 3%. While that is considered a major achievement for the Central Bank, all they have done in reality is accept that rates had reached a point of equilibrium at which they were neither affecting demand nor stimulating the economy.

Since the Fed announced a pause and the end of rate hikes, the dollar has been singly driven by speculation about when the first cut will take place. That was thought to have been delayed until the third quarter, but now the market expects the first cut to be agreed at the May meeting.

Every word that has been uttered by Jerome Powell has been studied for any subtle change to his rhetoric which may indicate when a cut will take place, but so far he has been stoic in his refusal to say any more than the Fed will stick to its programme of three cuts taking place in 2024.

The U.S. appears to be “decoupling” from the Chinese economy. With China continuing to struggle with oversupply in manufacturing, an ageing population, and a declining business environment, the U.S. economy is going from strength. With productivity levels at multi-year highs, employment data defying high-interest rates, and equity markets reaching historical levels, the U.S. is regaining its place as an economic behemoth.

China is suffering primarily from its reluctance to participate in the burgeoning “global system,” it is becoming clearer year by year that economic isolationism is not working.

In the U.S. jobs are becoming plentiful, with anyone who wants to find employment being successful. Especially in the over-55 demographic, there is a shortage of workers, with the numbers taking early retirement increasing. The incentives to continue working have been diminishing, and this has led to a lack of experienced employees and a skills gap in several sectors.

This week there is another “cut” of Q4 GDP due for release, although there is no major expectation for a change to the 3.3% increase that was published earlier.

The dollar index is lacking drivers to push it higher, although it retains significant support below the 104 level. Last week, it fell to a low of 103.43 and closed at 103.94.

ECB President Christine Lagarde has suffered a poor start to 2024. First, a survey of ECB employees regarding her first “term” in office was fiercely critical of her performance, and then the European Commission’s Financial Regulation Committee called her decision-making “political.”

Given the relative “immaturity” of the Central Bank, there is no precedence for the removal of its President. Many believe that Lagarde is simply suffering in comparison to her predecessor, Mario Draghi, although it is becoming obvious that the role is best filled by a bureaucrat rather than a career politician.

PMI data that was published showed that Germany, the Union’s largest economy and its main driver for decades, is in danger of becoming “decoupled” from the rest of the EU.

Germany is suffering from the rigidity of its economy, which is heavily reliant upon energy-hungry heavy industry. The geopolitical situation has been a significant contributor to the near relative of the German economy, as the Russian invasion has seen sanctions affect its previous healthy relationship with Germany.

Although there has been significant growth in Germany’s services sector, it still lags other EU nations in terms of innovation, while it is becoming clear that although it is suffering currently, China is far ahead in terms of output and productivity in the heavy industry sector and is encroaching on Germany’s traditional export markets.

The German Finance Minister was quoted recently as saying that the German economy has entered “troubled waters” although he stopped short of commenting on the “whispers” that are growing regarding its continued membership of the European Union.

Siegfried Russwurm, president of the Federal Association of German Industry, spoke recently of his member’s view that Germany is falling further and further behind and has no chance of recovering before the end of 2025.

The Euro is continuing to defy gravity as it is on a path towards another attempt to break the 1.10 level. Last week, the common currency reached a high of 1.0883 but fell back to close at 1.0822.

Have a great day!