Dovish Armour Blocks Senses
UK data releases contained some market-moving dovish surprises over the past week. Wages retreated in October after September’s surge, shocking expectations. Without revisions, which are consistently higher, growth may settle near 6% in the new year. Meanwhile, adjusted UK labour market data report the unemployment rate at 4.2% again, with activity levels still trending higher. Resilient wage settlements and a stable unemployment rate suggest the cyclical slowdown is ending prematurely, sustaining hawkish pressures (see UK: Growing Through Pay Blip).
UK GDP also disappointed by falling 0.3% m-o-m in Oct-23 rather than stalling. This drop reverses the surprising strength in Sep-23 and keeps GDP’s 2023 level broadly flat. Payback infected industries in the private sector in both directions while funds kept pouring into the public sector. The PMI-comparable sectors have remained flat. We now track no GDP growth in Q4, with the productivity lost to ongoing employment growth stoking unit labour costs. The inflation outlook remains inconsistent with rate cuts (see UK: Private Payback Flattens GDP).
These data releases, together with recognition by the Fed that they would cut more in 2024 and probably not hike again, caused a substantial dovish repricing for the UK. There are almost two more rate cuts in 2024 than were priced a week ago, with the first expected to occur in the spring. To sustain pricing for a move so soon, one might think the BoE had already turned dovish. The truth is quite the opposite.
The MPC pushed back against dovish pricing with its forecasts and interpretation of the news. It also pointed to how the UK’s fundamentals are worse than in the US and EA, with excessive wages and underlying price inflation preventing a sustainable return to target. Three MPC members still favour a rate hike, and most of the rest have a hawkish bias. The BoE looks nowhere near a cut, and nor should it be. We see it on hold through 2024 (see Rates: The Old Lady is Not for Turning).
The Federal Open Market Committee (FOMC) of the United States opted to maintain the current interest rate, acknowledging the slowing yet resilient nature of the US economy, with particular attention to GDP growth rates and labour market conditions. However, despite inflation easing, it remains above the Fed’s target, so the Committee remains ready to raise rates again if inflationary trends deviate from their target. At this stage, there is a high hurdle to that, with a rate cut already forewarned to prevent an excessive passthrough of past policy tightening. The market’s reaction suggests a comfort with pricing more aggressive cuts than FOMC members or the economic consensus expects.
The European Central Bank (ECB) also kept its interest rates unchanged, influenced by projections of gradually declining inflation and sustained domestic price pressures, especially from rising labour costs. This approach reflects the effective transmission of past rate increases and a cautious stance on economic recovery, focusing on maintaining rates conducive to achieving the 2% inflation target. Future policy decisions will remain data-dependent, emphasising the assessment of the inflation outlook and economic growth alongside strategic adjustments in asset purchase programs.
President Lagarde also stressed that the ECB was not considering cuts yet and that inflation risks remain. Private labour cost data provided a timely reminder of that underlying problem, increasing from 4.5% to 5.7% y-o-y in Q3. These data aren’t nearly as bad as in the UK but are inconsistent with a sustainable return to the ECB’s inflation target. Policymakers will want to see how the wage rounds develop in the new year and will probably wait longer than markets expect before cutting, given the excess here and global economic resilience.
Hawkish action rather than words came from the Norges Bank’s surprise 25bp rate hike to 4.5%. This decision focuses on combating inflation, which remains significantly above target despite some economic cooling. Future rate decisions will balance maintaining economic growth and employment levels against the necessity of controlling inflation, particularly under the depreciating krone's influence.
The Swiss National Bank (SNB) held its policy rate steady at 1.75% amid slightly decreased inflation, global economic trends, and moderate domestic growth. Future policy decisions will hinge heavily on inflation dynamics, global economic conditions, domestic performance, financial market stability, and foreign exchange market activities. The SNB maintains flexibility to adjust interest rates in response to significant deviations in inflation from the target range.
The Bangko Sentral ng Pilipinas (BSP) maintained its policy rate at 6.5%, driven by a slight moderation in inflation forecasts and anchored expectations. The Monetary Board shares the global focus on sustaining economic growth while managing inflation risks after its recent inter-meeting rate hike.
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The Banco Central do Brasil’s Copom reduced the Selic rate to 11.75%, aligning with expectations and reflecting a responsive approach to a less adverse global outlook and domestic inflationary pressures. The Committee’s decision is based on a balanced risk assessment, with continued rate cuts projected to ensure inflation expectations remain anchored.
Banco de México’s decision to maintain the overnight interbank interest rate at 11.25% also strikes a balance between mitigating high inflation and supporting economic resilience. Future policy will be influenced by headline and core inflation, alongside global and domestic economic trends and labour market strength, with adaptability to new economic data.
Finally, the BCRP’s reduction of Peru's policy rate by 25 basis points to 6.75% aligned with the economic consensus, driven by a consistent downward trend in inflation. The Board’s commitment to adjusting its monetary stance in response to evolving economic data underscores its vigilant and responsive approach.
Overall, these developments reflect a global monetary environment that strategically balances the management of high inflation and fostering economic stability. This is mainly done with unchanged policies, although some Latam banks are cutting. Readiness to adapt policies with the data after finishing the hiking cycle does not mean that cuts are coming soon. The inflation problem remains dominant in many countries, especially the UK.
Inflation Forecasts
EA HICP inflation is unlikely to be revised in its final release for November on 19 December. The flash was not close to rounding differently (i.e. 2.406%), and national revisions were offsetting. Specifically, Spain's and France's were revised up a tenth while Italy’s was trimmed by a tenth.
There has been a downward skew to inflation surprises over the past month, including in the flash EA release. We expect the UK inflation data to continue that pattern as we are a tenth under the current CPI consensus (i.e. 4.3% vs 4.4%). The BoE was at 4.6%, but the Oct-23 outcome was 0.2pp under its forecast and petrol prices have fallen since then, compounding the short-term weakness.