Should the Bank of England cut?
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This week we received yet more good news on inflation in the UK with a downward surprise taking the headline CPI (consumer price index) rate down to 3.4%. Like many market participants – and certainly mortgage holders in the UK – the question I’m pondering this month is when, and by how much will the Bank of England lower interest rates?
3.4% is still above the 2% inflation target but within the next couple of months, we expect a meaningful drop in household gas bills, alongside a further decline in food inflation, to take the headline inflation rate below 2%. Focusing on headline inflation alone, one would conclude that the job is done and the Bank of England can start to ease its foot off the brake.
However, while inflation is cooling on the surface, under the bonnet there are still signs of persistence. When removing the more volatile components from the CPI basket, namely food and energy, core inflation remains sticky. Although it decelerated in February, it still sits at 4.5% year on year.
Furthermore, the Bank has repeatedly expressed concerns around domestically-generated inflation originating from the services sector. Both regular wage growth and services inflation are still north of 6%, which could be a sign that the labour market and broader economy is at full capacity. The 9.8% increase in the National Living Wage (NLW) in April, which is expected to boost wages for about a tenth of the workforce, will add further fuel to wage growth.
If there were signs that the economy was losing economic momentum, the Bank might feel more confident that these residual inflationary pressures would dissipate. This doesn’t seem to be the case though. Despite entering a technical recession in the second half of last year, there has been an upswing in economic activity more recently.
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Consumer confidence has been trending up, retail sales rebounded in January, and business surveys have picked up, driven by strength in the services sector. The measures from the UK Budget should also provide a tailwind to growth this year, albeit a modest one, while falling inflation in itself could lead to a real wage boost and a reacceleration in spending. There is, therefore, a risk that sizeable premature rate cuts might further fuel the underlying capacity problem.
I’m left thinking that while progress has been made on inflation, we can’t yet be 100% convinced that the battle is over. While the Bank should be in a position to begin cutting rates later this year, the magnitude of cuts is likely to end up being relatively modest.
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President of Thibeault Financial Economics Inc.
9moYes Karen. I do think the Bank of England, the Fed, and Bank of Canada, should all cut rates in early spring. Why? To avoid the negative impact of the coming lag of the past rate hikes made in western economies the world over post covid / excess stimulus spending that followed that period. Leading economic indicators have been falling for 2 years now in the US and elsewhere and hence, it is wise to be anticipatory and ahead of the macro damage the past rate hikes do and instead get ahead of them and cut soon. The best example of a like event, is when Stanley Fischer cut rates at the Bank of Israel in late December 2008 and managed to help Israel side step the 2008-09 Great Recession.....
Senior Wealth Manager at Citadel Finance SA
9moAfter the SNB cut we may see the UK financial condition on a broader basis, while keeping in mind that Central Banks probably have little impact on the current inflation and individuals are still left with a lower purchasing power than pre Covid, hence current wage growth is not really inflationary ! (i.e. hopefully wages are rising after a cumulative price hikes of 20% since 2020). After the SNB move it is highly likely that ECB will cut in June and it is fairly likely that ECB and Fed will start cutting at the same time. We also have to keep in mind that while inflation comes down, real interest rates are rising (i.e. about 3% higher since August 23). Is it really reasonable to think that the UK economy is so strong that it can let its currency rise (if they don't cut) and its real interest rates rise ? It leaves little doubt of what I think about BOE next move but I would be interested to have your view about the international interactions I mentionned above. Thanks again for your comment and valuable guide to the Market.
Great move on their part not following the SNB. The CHF is taking a hit already. Thanks to the 25bps cut. But time will tell
Consultant, Chancery Lane Income Planners
9mofair points.....