‘On your marks, get set, go’
The Olympics is off with a bang. Athletes have long been preparing for their big day in the limelight. In the world of monetary policy, some central bankers have begun jogging along, others are waiting for their starting gun, but all look ready to race ahead with a series of interest rate cuts in the second half of this year.
The latest economic data from the USA sums up the situation which many policy makers are seeing. Economic growth was stronger than expected in the second quarter (2.8% on an annualised basis). The US consumer remains as robust as ever. However, the GDP measure of prices which the Fed pays close attention to decelerated to 2.3% a year. Indeed in most countries, headline inflation is inexorably declerating back towards target, helped by stable energy costs. The concern to many central bankers remains the mixed state of the labour market. Unemployment is low, but edging high, whilst wages are growing faster than policy makers would like to see, but decelerating.
Business surveys do not suggest much change in economic activity into the autumn. CIPS/ISM/PMI measures across the five largest developed market economies reported continued weakness in manufacturing (about 48, its lowest level since Dec 2023), but further strength in services (about 54, its best level since May 2023). Consumers currently prefer experiences to goods, where there are signs of excess inventories in many countries.
Will the Bank of England sprint out of the starting blocks this week? Analysts are divided 50-50. They had assumed that a rate cut was likely once the election was out of the way. However, a series of speeches has changed perceptions. Catherine Mann remains concerned about services sector inflation. Jonathan Haskel, at his last meeting on the MPC, has said that he does not want to cut interest rates as inflationary pressures remain in the job market and it is unclear how rapidly they will fade. Chief Economist Huw Pill said services inflation and wage growth showed uncomfortable strength. “ I think it is still an open question on whether the timing of a rate cut is now”.
The data is mixed. After the mild ‘technical’ recession last year, the economy has recovered, with GDP provisionally on course to grow about 1.5% annualised in the first half of the year. Decent real wage growth helped, so consumer-facing services saw output grow by 0.7% in May. However, Barclays Bank warned that consumer spending on its credit and debit cards was weak in June, the first fall since February 2021. Headline CPI has been at the 2% target for two successive months. Where next? A survey of CFOs in June reported that realized wage growth over the past 12 months had been 5.9% a year, but expected wage growth over the coming year was down to 4%. Indeed a recent survey from the CBI reported that falling manufacturing orders were feeding through into lower business optimisim and especially lower selling prices.
The US Federal Reserve is warming up and looks ready to start down the track in September. In recent speeches, Fed officials such as Waller, Williams, and Barkin all expressed confidence in the inflation path and state of the labour market. Bill Dudley, the former president of the Federal Reserve Bank of New York, suggested that the Fed should start cutting rates soon in light of increasing recession risks. Fed Governor Mary Daly summed up the situation, “With the information we have received today, which includes data on employment, inflation, growth, and the outlook for the economy, I see it as likely that policy adjustments, some policy adjustments, will be warranted”. All in all, September is seen as the month when the Fed will first cut interest rates, before the Presidential election in November restricts its ability to move, with a second move in December.
The ECB has already set off, and the latest economic data suggests it needs to do more into the autumn. The EU economy is only growing about 1% a year, largely due to various problems facing Germany. Markets think the ECB will move again in September and then December. Christine Lagarde hinted that August would be too soon: “It will take time for us to gather sufficient data to be certain that the risks of above target inflation have passed. The strong labour market means that we can take time to gather new information. A soft landing is not guaranteed”. Similarly, as Fabio Panetta said “The reduction of official rates can proceed gradually, accompanying the return of inflation towards the objective, if macroeconomic trends remain in line with the ECB’s expectations”.
The starting gun has been fired, the ECB has responded quickest, but the Fed and MPC look set to follow soon. Looking ahead, although some central bankers will move earlier and perhaps a little faster than their counterparts, all face the same terrain in front of them. Putting aside any new inflation shocks, markest expectations are that interest rates in the UK, USA and Europe will be about ½% lower by year end. Indeed, benchmark bond yields are all down about ¼% in the past month as such a view has begun to be priced into the markets.
Bond yields at the time of writing
10 year % Monthly move
USA 4.17 -0.24%
UK 4.06 -0.23%
Germany 2.37 -0.23%
Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making