7 August 2023: Falling inflation may be a pivot

There is a real belief in the market that the rate hike that was agreed at last week’s meeting of the Monetary Policy Committee will be the last in a chain that reached back over fourteen meetings in December 2021.

Andrew Bailey is not given to outward shows of emotion, but he was a great deal more upbeat this time than last.

There was confidence in his pronouncement that headline inflation would have fallen to 5% by October. This means that the Prime Minister would fulfil his pledge to see inflation halved by the end of the year, a promise that has been hanging over Bailey’s head like the sword of Damocles.

Since there are no satisfying journalists, Bailey was quizzed at his press conference about when he expects the Bank to be able to consider cutting rates.

Believing that he may be led into making a promise that he may not be able to keep, Bailey was forthright in his answer that “it’s far too early for that kind of speculation”.

However, even that answer was given a positive spin, in that his audience would have expected him to say that the Bank hasn’t finished its cycle of hikes yet, which led them to believe that now maybe it has.

Bailey went on to say that even within the committee, there are several presumed paths for monetary policy, each with its own supporters. That was yet another Central Banker saying that he will be data-driven.

Bailey mentioned his concern about the housing market, which reached deep into the health of the economy. He said it was natural that a tightening of monetary policy, like has been seen over the past eighteen months, would see the housing market suffer, but a realignment is the purpose of the Bank’s actions.

The housing market is cyclical and has been on a positive trajectory since the financial crisis that began in 2008 ended Further evidence of that will be seen later this morning with the release of the Halifax House Price Index, as well as like-for-like retail sales.

While both these are “Tier 2” releases, they are a contributor to overall consumer sentiment.

The market will then have a wait until Friday for the publication of a slew of “Tier 1” data. This will include manufacturing production, business investment, and a further estimate of Q2 GDP with growth of just 0.1% month-on-month expected, which may have led to a year-on-year contraction of 0.2%.

Sterling is beginning to see the support it is receiving from rate hikes peter out. Even if the Bank of England hasn’t come to the end of its rate hike cycle, it must be close to doing so.

The pound fell to a low of 1.2620 last week and closed at 1.2740.

Using the analogy that “if it looks like a duck, walks like a duck, swims like a duck and quacks like a duck, then it probably is a duck” to describe the possibility that a soft landing for the economy is already being achieved, market practitioners are predicting a further interest rate hike at the next meeting of the FOMC.

That is hardly a surprise since Jerome Powell almost confirmed such an outcome at his most recent press conference.

There has been a decided lack of comment from FOMC members since the meeting held almost two weeks ago about whether they support another pause, although Fed Governor Michelle Bowman spoke last week of her belief that further hikes may be necessary to “fully restore price stability.”

According to Bowman, these will be needed to see inflation fall to or even surpass the Fed’s target of 2% for headline inflation while the core remains “uncomfortably high.”

The current fed funds target is 5.25% to 5.50% which was where the market’s estimate for the peak for interest rates has been for a few months.

While the headline creation of new jobs was still showing signs of heat in July, when 187k new jobs were created, the Fed can be confident that this is an indicator of further falls to come.

The NFP figures are still a long way away from collapsing into negative territory, which would be a certain precursor of an economic contraction.

Powell believes that since the purpose of the chain of rate hikes that it has delivered since this time last year was designed to slow demand in the economy, there should be less concern when that promise is delivered upon.

The FOMC has proclaimed that it is also data-driven, and the data since the FOMC meeting points to a further pause. Inflation data is due for release this Thursday and is expected to see a further fall from last month’s headline reading of 3%, although the core will confirm Michelle Bowman’s belief that it is uncomfortably high, only falling to 4.7% in July from 4.8% in June.

The dollar index moved further away from its medium-term support level last week. It reached a high of 102.84, but in a thinning market, ran out of momentum and closed at 102.01.

Since there is no one in Frankfurt to argue against a pause in rate hikes at the next meeting of the ECB Governing Council journalists have got it into their head, and column inches, that the doves have finally prevailed and the end of the current cycle of hikes which began after the rest of the G7, has ended, or will at the very least be broken.

It is reasonable to expect that there will be more hikes in the pipeline unless the idea of higher for longer is adopted as policy, but that is unlikely to appease the Frugal Five, who want inflation crushed as soon as possible.

The CFO of one of Germany’s largest banks spoke on Friday of his view that the ECB has already decided to “hit the pause button.” Bettina Orlopp believes that according to her team’s models, 3.75% will remain the rate for “a couple of months.”

Confirming the second quarter results at Germany’s second-largest lender by market capitalization, Orlopp said Commerzbank’s performance is driven partly by the interest rate environment, and although there has been a slowdown in lending over the past one and a half quarters, consistent with rate hikes, she doesn’t believe that it is the intention of the Central Bank(s) to see bank lending decline further.

In truth, no journalists can find any Governing Council members since they are all on holiday, and even if they could, it is unlikely that they would wish to comment on how they will vote in September. Therefore, the jury is most definitely out on the prospects for the September meeting.

There is a mixed picture of the economies of the Eurozone currently. Germany and Italy are almost certainly in recession, but there was better news from France.

This has been a typical summer story so far for France. Rioting youth in several major cities, while earlier strikes have been quelled for now by an unpopular Government.

However, despite chilling stories of an immediate recession that will last the rest of the year, France managed to produce growth of 0.5% in Q2. While this is “nothing to write home about”, it is a far better story than it could have been.

The actions of the ECB so far this year, coupled with the balance of individual growth stories, depict an overall economy teetering between recession and inflation. Although the result of the September meeting will not be decisive, there are sure to be further hikes this year, it would show a degree of rational thought since, as Christine Lagarde has often said, it is not the intention of the Central Bank to drive the economy into recession.

The euro is showing a degree of resilience, rising above the 1.10 level last week and reaching a high of 1.1045. It ran into mild selling pressure, which pushed it back to 1.0912 but recovered to close at 1.1008.

Have a great day!