Welcome to the start of December and the inevitable opening of chocolate advent calendars (although my pointing out of the price/weight ratio of chocolate in a calendar versus a simple bar of chocolate has once again gone ignored).
Anyway, as the month begins it all seems to have gone a little quiet. There has been very little news flow, but the start-of-month data is due today which, along with a raft of central bank meetings over the next few weeks, means 2023 is not quite finished with us yet. Ahead of those meetings we heard from plenty of central bankers ahead of the pre-meeting blackouts on comments.
Bank of England (BoE) governor, Andrew Bailey, once again sounded downbeat on the economic outlook for the UK. He noted his concern for the UK’s potential for the economy to grow, saying, “There’s no doubt it’s lower than it has been in much of my working life”. Deputy governor, Dave Ramsden, warned of high services inflation, saying it would be “really challenging” to squeeze inflation out of the system, with the BoE expecting price growth to remain “stubbornly high” throughout 2024 because of high wages. Monetary Policy Committee (MPC) member James Haskel stated that a tight UK labour market meant there was “no scope anytime soon” to lower borrowing costs, which would “have to be held higher and longer than many seem to be expecting”.
At the European Central Bank (ECB), president Christine Lagarde echoed the “higher for longer” messaging, remarking it was “not the time to start declaring victory” on inflation and that the ECB expected that “maintaining interest rates at current levels for a sufficiently long duration will make a significant contribution to restoring price stability”. The comments in the UK and eurozone appear to be falling on deaf ears, however, with market expectations for rate cuts in 2024 continuing to rise.
In the US, rate cut expectations are building even faster, with any dovish comments fuelling this trade while hawkish comments seem to go unnoticed. Federal Reserve governor, Christopher Waller, said earlier this week that he was “increasingly confident that policy is well positioned to slow the economy and get inflation back to 2%”. He hinted that rate cuts were possible in the first half of 2024 if inflation behaves as he thinks it could. Meanwhile, his colleague John Williams said, “The inflation trajectory has turned”. More hawkish comments from Fed board governor Michelle Bowman that she “continues to expect we will need to increase the Fed Funds Rate further” failed to dampen the mood. Futures markets are now pricing a 100% probability of a rate cut in the US by May, and a total of 103 basis point cut in 2024. A rate cut in this timescale certainly fits with what we’ve seen in the past, but history also shows markets perform well in the period between the pause and the first cut, but poorly after that first cut – usually because the economy is in a downturn or recession. So, enjoy the party while it lasts.
Economic data has helped market expectations for rate cuts after German inflation in November eased to 2.3% year on year. Eurozone CPI was also lower than expected at 2.4%, down from 2.9% in November, and the slowest pace of price rises since July 2021. With a stagnant economy and inflation moving towards the ECB’s target, markets are now pricing a 25 basis point rate cut from the ECB by April. The flash PMI data was generally ahead of expectations in the eurozone, UK and US, with the latter two seeing composite figures in “expansion” territory. Again, this helped the market mood giving some hope for a “soft landing” as we go into 2024. The equivalent PMI data from China sent mixed messages, with the official numbers pointing to contraction while the unofficial ones were a little more upbeat. Either way, the consensus view remains that China will need further stimulus to improve its economic prospects.
The OECD updated its World Economic Outlook on Wednesday and countered the prevailing mood in financial markets around rate cuts by warning that western central banks may need to keep interest rates at high levels until 2025 to guard against stubborn inflation pressures. The OECD does not foresee rate cuts from the ECB or the Bank of England until early 2025, though it expects the Fed to keep rates on hold until the second half of 2024.
OECD chief economist, Claire Lombardelli, said it expected a “soft landing”, but the report also warned that the “full effects” of the rate tightening over the past two years had not yet fed through. The OECD said it foresees average inflation of 5.8% in the G20 in 2024, easing to 3.8% in 2025. This compares to 6.2% in 2023. It also expects global growth to be 2.7% next year, the weakest level (outside of pandemic-impacted 2020) since the global financial crisis. The OECD also warned that many developed countries faced “sizeable risks” to their long-run fiscal sustainability without more significant efforts to rein in public borrowing. Politicians, take note. Given the number of elections in 2024 this is likely an issue that will be pushed down the road, unless bond markets decide to impose some discipline.
Have a good weekend,
Regards,
Anthony.
