Central bankers may feel pretty pleased with themselves. Inflation has come down to more normal levels – albeit not quite 2% everywhere, and we’ve avoided a big recession. So far so Goldilocks. The financial system has held up well and stocks keep hitting record highs. Time to do a victory lap? Well, maybe not. Luck may have been the main force. The central bankers performed their task without breaking things. But prices may have normalised anyway; prices rose due to unprecedented shocks that would not be repeated (covid, Ukraine); economic, particularly labour market, readjustment post-pandemic was always going to happen to ease the supply side; and the transmission of monetary policy was not terribly strong in a lot of places, easing pressure on firms whilst other factors drove disinflation.
On the last point…we know that monetary tightening had a much bigger effect in places like the EU and the UK than it did in the US. The US has higher shares of fixed-rate mortgages and corporate debt being termed out at fixed rates, and American firms are also overall less reliant on the banking system. So the risk for countries like the UK is overtightening – and there may be a risk that this happens if the Bank of England does not move soon.
Inflation is down to 2% in the UK, placing in the first tier of inflation-busters. But will the Bank of England cut interest rates in August? Not so fast, say a couple of policymakers.
A sharp decline in inflation has set up a potential rate cut from the Bank of England this summer. CPI inflation declined to a rate of 2.0% in May, according to the latest figures released in June. But market expectations for a rate cut in August, when the Bank of England next meets, may be wide of the mark.
On Monday MPC member Jonathan Haskel said he “would rather hold rates” until there were further signs of cooler inflation. Whilst there are “encouraging signs” of cooler inflation, he warned that there is still pressure from the tight labour market.
“The playing out of those shocks through the economy, and the continued tight and impaired labour market, means that inflation will remain above target for quite some time,” said Haskel, a member of the Bank’s monetary policy committee (MPC), in a speech at King’s College London on Monday.
Now Huw Pill, the BoE’s chief economist, has also chimed in with comments that seem to suggest the MPC is leaning towards holding interest rates steady next month. Speaking this week he pointed to the “persistence” of underlying inflation, noting that services inflation and wage growth remain close to 6%. He also noted “some upside risk” to his assessment of this persistence. It probably makes next week’s CPI report make or break for an August cut. Markets trimmed bets from around a two-thirds likelihood of a cut next month to 50/50 after Pill’s remarks.
Meanwhile Britain’s key service sector (number two exporter after the US) rebounded nicely in May to help push GDP growth to 0.4%, twice the rate expected. Construction rebounded 1.9%, growing at its fastest rate in a year. Certainly, it looks as though there are tailwinds for the UK economy.
The comments and the data helped lift sterling to extend the run higher for GBPUSD north of 1.2860, its best in four months. Then came a soft US inflation report, which helped push cable up to its best in a year.
The lowest CPI inflation report in three years sent Treasury yields plunging and the dollar dipped aggressively lower to send major peers to their highest levels in months. Gold rose back above $2,400, not far from its all-time high. The 10yr TIPS dipped to 1.975%, down from 2.250% at the end of May.
The June CPI print fell to 3% and prices declined by 0.1% month-on-month. Shelter costs finally normalised. The odds of a rate cut by the Fed in September jumped from 70% to almost 90%. Last mile? I’ve said for ages they won’t push to get from 3% to 2%. The job has been done and they will accept slightly higher levels of inflation now.
Nevertheless, we could see the Fed cut before the Bank of England does.
Neil Wilson
Chief Market Analyst at Finalto
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