“Am I part of the cure or am I part of the disease?“
Clocks, Coldplay
Last week, we discussed the evolution of UK monetary policy expectations following on from the Bank of England decision that brought two dissents in favour of a 25bp rate cut and sharply downgraded central inflation projections (well below target at the forecast horizon). We argued that these two factors amounted to a milestone for the Bank of England as the direction and intent of monetary policy became clear. The timing and cadence of the rate-cutting cycle in the UK, however, is a little more moot.
Start the Clock
Indeed, this week's developments have made the rate cut calculus even more complicated. While we refrain from making any political statements, the announcement of the timing of the UK General Election is significant for the Bank of England. Regular readers will be aware that we favoured the August 1st policy meeting as the start of the rate-cutting cycle in the UK (since August is an MPR month and thus comes with the added information of updated economic projections - providing additional confidence to the MPC). The election date of 4th July almost certainly puts paid to thoughts of anything earlier than August. The issue, however, would be if there is not a clear winner of the election on July 4th (and thus a window of coalition building) or if there is any uncertainty over the fiscal framework or spending commitments of the new government, meaning that the MPC could not incorporate fiscal plans into the updated projections - and hence may be more cautious about initiating a rate cutting cycle.
Almost back to target
This week, the release of UK CPI for April was another step in the right direction. Markets appeared underwhelmed by the headline print coming in at 2.3% y/y and the core at just 3.9%. From our perspective, however, this feels a little like an issue we had concerns about at the back end of last year, where commentators were overly focused on the sequential movements and the data relative to ‘expectations’ and not enough focus on the absolute level of the data.
The Bank of England has been very clear that the current policy setting is significantly restrictive. We would expect that equilibrium rates in the UK are close to half the current policy rate. Indeed, the current policy rate peak was reached with a headline inflation rate of 6.8%, and we would argue that it is currently too restrictive against an economy with little to no underlying growth. The upside miss relative to expectations was notable in the services component, and this has also sparked some concern about the continued upside risks to inflation from domestic demand. We remain cautious in this regard and cognisant of the ‘noise’ around episodes of base effect adjustments over the past year or so. We continue to see inflation and policy trajectories as clearly lower - albeit with the complication of avoiding the election.
The significant downside miss to retail sales at the end of this week is a timely reminder that the growth / inflation trade-off in the UK is complex. For us, delays to the BoE cutting cycle likely mean bigger cuts further down the line!
Various > Several?
This week, while relatively quiet from a US data perspective, saw the release of the minutes from the May 1st FOMC. Last week, we highlighted our view that the downside surprise in the April CPI print (as well as the labour market normalisation progress in the April NFP) would likely detract from the scrutiny with which the Fed minutes were viewed as the data make the hawkish interpretation of the previous data (Q1) less relevant.
The minutes categorised FOMC members into groups: ‘some’ emphasised that the Q1 inflation increases were broad-based, ‘a few’ highlighted seasonal distortions pushing up Q1 core PCE, ‘several’ commented on the rapid growth of the private credit market, ‘a number’ noted the risk that financial conditions were too easy and , ‘various’ participants stated that they were willing to tighten further of needed. The market reacted to the last point about the prospect of higher rates (not least because ‘various’ was a new fed term in the spectrum of quantitative order - and thus commentators did not know if ‘various’ was a bigger number then ‘a few’ or ‘several’). However, we would argue that the market pricing at the time of the May 1st FOMC implied a probability of a rate hike in the US at around 30%. Thus, it is not surprising that various members raised the possibility, if needed. Current market pricing is closer to zero.
What about growth?
Ultimately, despite a lot of volatility in the data and indeed in the Fedspeaker commentary, we continue to see disinflation as the dominant theme. While the market continues to see inflation as the dominant macro factor (in the US and the UK), from our perspective, growth is the likely dominant policy swing factor. In the US, for example, while we retain the view that inflation will continue to moderate and that the Fed retain an asymmetrically dovish reaction function while rates remain in restrictive territory, fiscal support (as well as some more idiosyncratic demand drivers in the US) likely means that pockets of ‘sticky’ inflation reduce the confidence of policymakers to cut rates. From our perspective, a higher unemployment rate can boost that confidence very quickly and (like in the UK) the risks of faster rate cuts in the US towards the end of the year remain a distinct possibility.
The Long & Short it…
There are very many elections in the global economy this year, and it is unlikely that the UK is the only one to potentially set MP’s and MPC’s in conflict. To quote Coldplay, the political cycle in the UK has the potential to disrupt the monetary cycle. Time will tell whether the “closing walls and ticking clocks” of the UK General Election will mean the Bank of England will “curse missed opportunities”!
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