Ear to the Ground

02 February 2024

It was the Bank of England’s turn this week to vote on interest rates and, in line with consensus forecast, they voted to leave the base rate unchanged at 5.25%.  What was perhaps a little surprising for some was that the decision was by no means unanimous, with six members voting to leave unchanged, whilst one voted for a rate cut, with the remaining two voting for a hike of 0.25%. 

The decision to hold comes despite the expectation that inflation is forecast to hit 2% in the second quarter of this year.  They believe that this will be temporary however and that inflation should pick up in the third and fourth quarter due the impact of the energy price becoming less negative.  So, a product of math.  Based on the market implied path of interest rates, it is forecast that CPI inflation will be at 2.75% at the end of 2024, then remaining above the 2% target for the remainder of the forecast period to the end of 2025.  If interest rates were to remain at 5.25% the Bank of England estimate that inflation would fall well below the 2% target.  Interest rate cuts are therefore, you could argue, inevitable, it just depends on when and by how much.  It would appear that the central bank along with others such as the US Federal Reserve, remain data dependent.

In the eurozone all eyes were focussed on the release of inflation data for January after President Lagarde had warned the previous week that monetary policy was likely to remain tighter than the market was currently anticipating.  There was little surprise in the numbers, with the year on year inflation rate coming in at 2.8%, in line with the consensus forecast and marginally below the 2.9% posted the previous month.  Core inflation, meanwhile, which excludes the more volatile items of food and energy, rose 3.3% year on year, a little above the consensus forecast of 3.2% but still lower than December’s reading of 3.4%.

Also out of the area were the first estimates for economic growth for the fourth quarter.  Overall, the euro area economy grew 0.1% year on year, marginally beating expectations for no growth during the period.  Performance by member countries varied greatly, however.  Spain and Portugal were up there as the strongest performers, posting growth rates of 2% and 2.2% respectively.  There were also positive rates of growth from France (0.7%) and Italy (0.5%).  Conversely, the largest economy in the trading area, Germany, posted a contraction of 0.2%.  This was the second quarter in a row and therefore the economy has entered a technical recession.

In the US, at the time of writing, the market is waiting on the release of the non-farm payroll data for January.  Out of the data that has already been released this week we would draw attention to manufacturing data from the Institute of Supply Management (ISM).  Here we saw the purchasing managers index (PMI) rise to 49.1 in January.  Whilst this still represents the sector being in contraction, it was a stronger number than the 47.1 posted the previous month and compared to the consensus forecast of 47.  Pleasingly, there was a jump in new orders, the index rising from 47 to 52.5 and production from 49.9 to 50.4, therefore both indices representing expansion.  One to watch for those inflation hawks, however, was the prices element, which came in well above the consensus forecast of 46.9 at 52.9.

The debate on when we see the first rate cut continues to rumble on, particularly after the Federal Reserve Chair Powell was quoted in saying that “March is not the base case to start the cutting cycle.”  They appear confident on the direction things are taking.  “The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run.  The Committee judges that the risks to achieving its employment and inflation goals are moving into better balance.  The economic outlook is uncertain, and the Committee remains highly attentive to inflation risks.”

I guess we know that they are coming at some juncture, but timing is the uncertainty.

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