3 June 2024: Is the BoE truly independent?

Andrew Bailey has often fiercely defended the independence of the Monetary Policy Committee, but last week Rishi Sunak caused that independence to be questioned yet again.

Sunak told reporters that a vote for the Conservative Party should be considered a vote for lower interest rates. Although it is creditworthy that his vow that the headline rate of inflation would be halved during his first year has happened, it is questionable how much the Government’s policies had to do with the fall.

The Conservatives consider themselves to be the Party that is committed to bringing down inflation. Because interest rates can only be lowered if inflation is on a sustained downward path, it is obvious that both major parties are committed to lower inflation and therefore lower interest rates.

However, it is the nature of political campaigning that if one Party makes a claim about the economy (or immigration, or NHS waiting lists) the other must either “top” their claim or refute it.

The independence of the Bank of England is now well established. It would be unthinkable for it to be taken back under the Control of the Treasury. In fact, despite being the Party that gave the Central Bank its independence in 1997, Labour is the one that is currently mulling over changes to its status.

The most radical suggestion that has been made is for the Committee to include a representative from the Treasury, who can provide greater insight not only into the Government’s policies but also its thoughts on longer-term borrowing and fiscal planning.

The MPC does seem to operate in something of a vacuum, so a member in touch with the reality of Government would be an eminently sensible suggestion. If the replacement were to come from the independent group, such a consideration would hardly affect the balance of the current voting process.

The most recent meeting of the MPC voted by 7-2 in favour of leaving interest rates unchanged. Given the divergence of G7 member’s monetary policy expected to begin this week, the “smart money” is expecting the Bank of England to be the “next cab off the rank”.

Although inflation remains stubbornly high, Bailey has been more forthright about what conditions need to be met for a rate cut to take place.

While Christine Lagarde was adamant that inflation would need to reach the ECB’s 2% target before cuts took place to allow a series of cuts to happen, the doves on the Governing Council have managed to change her mind.

The Fed continues to “flip-flop,” apparently remaining data-driven. That will always be difficult at the end of a cycle since the data often throws up anomalies.

The pound is not taking much notice of the vagaries of the election. It will only move significantly if the Conservatives are radically cutting Labour’s lead in the opinion polls, which, so far, is not happening.

Sterling rallied to a high of 1.2761 last week and closed at 1.2737.

The music which accompanies the apparent game of “pass the parcel” that the FOMC undertakes to allow its members “unobstructed access” to the press appears to have stopped with Neel Kashkari in possession.

The Minneapolis Fed President is no stranger to the limelight, consistently being happy to provide the press with sound bites which often reflect the views of the entire committee.

Kashkari continued the theme regarding a delay in interest rate cuts due to the stubbornness of inflation. Price rises as measured by Jerome Powell’s favoured metric; Personal Consumption Expenditures fell marginally from 3.7% to 3.6% in Q1.

Kashkari told reporters that the FOMC is likely to leave rates unchanged for an extended period because the potential cost of prematurely declaring victory over inflation would be too high for it to consider.

He believes that the FOMC should err on the side of caution, since to be seen to have to raise rates if inflation were to begin to rise following a rate cut would damage the Committee’s credibility.

Along with decisions on monetary policy, the FOMC is still “tinkering” with the size of its balance sheet.

Several market commentators believe that if the Fed seriously wants to see inflation fall, it should be more aggressive in ending its debt purchases.

QE has been around since 2008. At that time, it was considered a “last gasp” policy to try to inject liquidity into the market. Now it has become a legitimate policy tool. If Central Banks genuinely want to see inflation fall, QE should be placed back in the cupboard and marked “for emergency use only.”

Kashkari is concerned about the continued resilience of the housing market, as well as the continued strength of job creation.

The Fed will receive another set of data later this week as the May employment report is published. Early predictions are for a moderate rise in the headline non-farm payroll number to 180k from 175k in April.

Some economists are predicting a significant fall in job creation, to as low as 125k. That highlights the impossibility of predicting this dataset since even jobless claims are not correlated to any degree.

The dollar fell to a low of 104.33, but it is continually making higher lows. This indicates a good degree of support. It is expected to rally later in the week as the ECB cuts interest rates, but a lot will depend on the relative dovishness of Christine Lagarde’s press conference.

It was not supposed to be this difficult.

When the time came for the ECB to cut interest rates, inflation was intended to have been at or very close to the ECB’s 2% target while the economy should have been deep into its second quarter of recession.

The reality has turned out to be quite different.

Although the economy could certainly do with a rate cut, it is still “bumping along the bottom” and producing occasional glimpses of a brighter future, while the inflation report that was published on Friday showed that inflation had risen to its highest level in four months.

The Eurozone economy suffered particularly badly from the gyrations in energy prices, which were uniquely driven by Russia’s tampering with gas supply. This drove the cost in the energy-hungry industrialized economies like Germany to historically elevated levels.

As the energy price has fallen, the Eurozone has been afflicted by unseasonably high prices for grain and other staple foodstuffs, which have kept inflation from falling close to its target.

There is no doubt that the hawks, on the Executive Committee and the Governing Council, are concerned that a single rate cut will not satisfy either the market or its hawkish members.

One redeeming feature of a single cut is that the Euro is unlikely to be overly phased by such action, particularly if it is accompanied by a statement which prepares the market not to expect a second cut until the Autumn.

There was a lot of discussion earlier in the year about the level of employment and wages, and how Q1 wage growth would be critical when considering a rate cut. Unemployment has again reached historic lows, while wage growth in Germany was almost three times the headline rate of inflation.

Once the dust settles, the Eurozone will be left in roughly the same position as it is now. A single cut is not going to improve the situation radically, but the ECB is committed to this week’s cut even if it is not warranted.

The euro remained within its recent range as the market prepared for increased volatility this week. A lot will depend on the tone of Christine Lagarde’s press conference, although it may be overshadowed by comments from members of the Governing Council who will want to provide their take on the vote.

The Single currency reached a high of 1.0889 and closed at 1.0853.

Have a great day!