Just be patient, summer will eventually arrive
Gardeners are keen on getting out into their garden, but they need to be patient with such wet windy weather. Looking ahead, April showers could be a problem too. Eventually the summer will come – patience is a virtue.
It is the same for investors. Interest rate cuts may eventually appear, but perhaps not as large as many had hoped. Economic growth is improving, and core inflation only slowly declining. The conclusion from Andrew Bailey at the Bank of England, that “We’re not yet at the point where we can cut interest rates, but things are moving in the right direction” is a view which many policy makers would echo.
When the MPC looks out across the world, there is evidence that the phase of weak growth seen last year is easing. One of the surprises in the Fed’s latest assessment of the state of the US economy was its upgrade to expected US GDP growth this year, towards 2 ½%. The global backdrop is helpful too, with ISM/PMI business surveys not as weak for manufacturing and edging higher for services. The net result is that whilst tighter monetary policy is causing unemployment to rise slowly in most countries, the deterioration is modest.
Tight labour markets mean wages growth remains above the levels which central bankers would like to see. Although headline inflation continues to decline, helped by declines in oil prices earlier in the year, the levels of core inflation being experienced remain on the high side. The latest figures were 3.1% pa for the Euro area, 3.8% for the USA and 4.5% for the UK.
Central bankers are preparing the ground for rate cuts, but the earliest would appear to be June for both the Federal Reserve and ECB. There is some speculation about May for the MPC but August is seen as more likely for the UK. The Fed is still expected to lead the way. For example, in his recent testimony to Congress Fed Chair Jay Powel suggested an inclination to cut interest rates to a more neutral level, but with inflation still above target and the activity data beating expectations the central bank is not yet in a position to do so. “As I said last month, much more evidence of slack appearing in an economy is required before markets can start to price in more optimistic rate cut views”.
The stance from the ECB was similar at its latest meeting. Policy makers repeated that they need more evidence that inflation is under control and that ongoing wage increases will not give it another leg up. Amongst influential speakers, Christine Lagarde said “We will know a little more in April, but we will know a lot more in June”. Bundesbank President Joachim Nagel said the ECB may be able to cut rates before the summer break, which starts after the July meeting. Pablo Hernandez de Cos considered that the differences of opinion within the central bank on a June rate cut were legitimate but relatively limited.
An interesting aspect of the debate across policy makers is the view that even when rate cuts do begin there may not be as many as currently priced into the markets, usually 3 by the end of this year. In the USA, for example, Bostic has argued that there is no urgency for rate cuts in view of the strength of the economy. Indeed he scaled down his rate cut expectations this year to just a single ¼% cut from two previously expected, citing persistent inflation.
Turning to the UK, the independent Office for Budget Responsibility thinks that the UK’s modest recession is over and that activity will pick up, with GDP growth of 0.8% in 2024 and 1.9% next year. It forecasts headline inflation temporarily dropping below the Bank of England’s target of 2.0%, reflecting energy costs, and staying around the target level for the next three years. The Bank will also be reassured that UK businesses reported their lowest inflation expectations in two-and-a-half years, according to its Decision Maker Panel survey. Job vacancies in England have fallen to their lowest level in more than three years, according to job site Reed. Whilst the Chancellor did give away about £10 billion of national insurance cuts in the Budget, this will only will provide a modest boost to the economy. Lower interest rates would certainly be appreciated by the Government. One worrying aspect of the Budget was an announcement from the Debt Management Office that an even higher amount of government debt (about of £265bn) would have to be issued in the next fiscal year, of which an increasing amount is needed to pay the interest on existing debt. Amongst G7 countries, only Italy has a higher ratio of interest payments to GDP than the UK.
At its latest MPC meeting, interestingly it was the first time no members voted for a rate hike; instead, there was an 8-1 majority vote for a hold. Next month may see some calls for actual reductions. The seasons are slowly changing – better weather and easier monetary policy loom ahead.
Bond yields at the time of writing
10 year % Monthly move
USA 4.24 -0.04%
UK 4.01 -0.19%
Germany 2.33 -0.13%
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