The turnaround in market expectations for interest rates in the US since the start of the year is astonishing. Forecasts of six rate cuts this year have been replaced with a conviction that the Federal Reserve has now shut the door on a June cut and might have shaved a mere single quarter point off interest rates by the end of 2024. Analysts at Bank of America believe the Fed’s first cut won’t come until December.
Admittedly the downward movement of inflation in the US has stalled. There have been three successive increases, the most recent being a rise in CPI inflation from 3.2 per cent in February to 3.5 per cent in March, while the nation’s economy, and the jobs market, continue to perform strongly. Cutting US rates now would be adding fuel to inflation’s tank, especially as the prices of oil and other commodities are rising as the global situation becomes more volatile and bleak.
In stark contrast, UK price growth has been trending down steadily and figures released this week confirmed that the pace of price rises had eased again – to 3.2 per cent in March, albeit a fraction higher than the predicted 3.1 per cent, compared with 3.4 per cent the previous month. This isn’t terribly surprising given the inflation dynamics are completely different in the two nations as Bank of England governor Andrew Bailey commented at an IMF meeting this week. There is much more demand-led pressure in the US. With new jobs being created at a rate of knots, portfolios bulging with gains from US tech stocks and healthy returns on cash savings, no wonder US consumers are feeling confident. The IMF is predicting economic growth of 2.7 per cent for the US this year.
Growth in the UK has, while improving lately, of course been much weaker and the IMF reckons the economy will expand by only 0.5 per cent over the same period. But despite falling inflation and the sluggish economy, there is still a real chance the Bank will wait beyond June to cut.
First, watching inflation’s stubborn grip in the United States may act as a further cautionary rein on more hawkish committee members who harbour concerns over second-round effects. They will want to see more evidence that inflation is properly neutered. MPC economist Megan Greene recently argued that expectations that the Bank will cut rates earlier and by more than the Fed this year may be plain wrong.
Some of those feared second-round effects can be seen in wage growth. Wage growth in the three months to February had been expected to fall but instead stayed firm at a rate of 5.6 per cent. ING Economics, which narrowly favours an August rate cut over June, says this stickiness is a concern. It’s a significant component of services sector price growth and will certainly give the MPC pause for thought given UK services inflation is running hotter than in the US.
The MPC might also consider that monetary policy is not particularly restrictive. The economy has shrugged off a light recession with consecutive rises in GDP in the first two months of the year, and a strong performance from manufacturing in particular in February. Growth rates could surprise to the upside as cuts to national insurance rates, potential further tax cuts ahead of the general election, falling inflation and reduced mortgage costs boost household incomes. ING thinks the economy is poised to grow by 0.3 per cent in the first quarter as a whole, which would be ahead of MPC forecasts. But with GDP on track to comfortably exceed the growth forecast of just 0.1 per cent, Pantheon Macroeconomics warns that the “MPC is lacking a clear trigger to act quickly”, although it believes a June cut will happen.
A final obstacle to a June move could be the critical feedback received from the former Federal Reserve chairman Ben Bernake on the Bank’s forecasting record. His rebukes might encourage it towards caution to re-establish its credibility.
But there is also a strong case for cuts. Inflation is falling in line with expectations and it seems highly unlikely the UK will now experience a US-style upturn. Still, the market is wavering between June and August for the first move and Capital Economics notes that the chance of a cut in June has fallen to 40 per cent, from 68 per cent before the US inflation release – and consensus opinion is now on the side of two 25 basis points cuts this year.
Whether it’s weeks or months away, what is certain is that when cuts start, they will be carefully paced.
