Rate Cuts Not Boxed In
It’s been a packed week for UK economic news, with relatively small and partly offsetting surprises netting out to be slightly hawkish. The dovish BoE can welcome the headline CPI inflation rate matching its forecast and the renewed slowing in the headline wage growth rate despite current levels remaining inconsistent with the inflation target. It can also lean on its expectation that things will keep improving.
Although UK inflation was broadly unchanged and close to expectations in June, services prices were surprisingly strong again. A temporary weakness in goods just offset this. Seasonal goods discounting is unsustainable disinflation while underlying pressures remain too high, and their persistence is raising consensus forecasts (see UK Discounts Soften Stronger Services). It is not a coincidence that monthly pay growth is consistently annualising above 5%. The labour market is slackening too slowly, with underlying changes becoming more neutral, vacancies rebounding to March levels, and redundancies remaining low (see UK: Slow Slackening Progress for Pay).
We still don’t see UK data as consistent with a sustainable return to the inflation target, so we believe the BoE shouldn’t be considering rate cuts. However, we must start from their baseline, where most MPC members either voted for a cut or saw the decision as “finely balanced” in June. The news since then has been relatively small, so we still expect an August rate cut. Nonetheless, we can’t rule out a more substantive reassessment of older information that prompts a delay. The MPC still has flexibility.
The BoE also has the flexibility to fix its poorly designed QT program with the new government. Its gilt holdings and sales are creating fiscal costs that are unnecessarily large. Restoring the proper separation between the BoE, HMT, and DMO would help. Swapping the BoE’s gilt portfolio for T-Bills with the Debt Management Account would break undesirable linkages and avoid crystalising mark-to-market losses to the deficit. Borrowing would be about ￡10bn per year less, creating welcome fiscal space and the political victory of clearing up a costly Conservative mess of institutions Labour set up (see Fixing QT Costs).
The ECB also preserved flexibility as it unanimously held its policy rates in July, as widely expected after June’s cut, and refused to pre-commit to any outcome in September. Its policy will depend on the data in the weeks and months ahead, with some policymakers likely to firm up their positions before September’s highlighted meeting. We still expect another cut in September, encouraged by the Fed and BoE also easing policy. However, premature global steps could swiftly require reversals in 2025 (see ECB: September Cut Not Yet Determined).
Next week, the Bank of Canada may announce a second consecutive rate cut rather than let the on-hold Fed box in its policy. It probably doesn’t have to wait long until the Fed joins in, with our September view widely embraced by the consensus and market pricing. Canada’s rising unemployment and surprisingly soft inflation provide the latest dovish impetus.
Recent increases in the oil price shouldn’t concern dovish global monetary policymakers. The Opec secretariat’s bullish July forecast for oil demand is an outlier relative to the industry near-consensus, which is closer to the assessment of the International Energy Agency. Therefore, Alastair Newton advises treating the recent uptick with caution (see Oil: An Unsustainable Uptick?).