Key Takeaways
- So far in 2024, US, UK and European markets have become less optimistic around the timing and scale of rate cuts this year. But things are changing.
- The European Central Bank has clearly signalled a cut in June.
- Hopes for a June cut in the UK have revived with inflation set to fall below target in the next few months.
- Key inflation data in the US has deteriorated of late and we will be watching upcoming employment data closely.
- With nominal rates on hold, real rates have been rising as inflation falls – central banks should be wary of tighter conditions and move to cut rates.
The markets in Europe, the UK and US have become less and less optimistic this year about the scale and timing of interest rate cuts, though this didn’t stop equities rallying strongly.
The chart plots the size of official interest cuts priced into the markets by the end of June for the US Federal Reserve (Fed), European Central Bank (ECB) and the Bank of England (BoE). At the start of 2024, all three were expected to deliver roughly the same cuts – 50 bps by June. Since then, the three profiles have been remarkably similar despite the big differences in the respective economies. But given that central banks are likely to move in quarter point steps, the chances of a cut in June differ markedly: 100% for the ECB, little more than 50:50 for the Fed with the BoE in the middle.
At her press conference last month, the President of the ECB came as close as she ever does to pre committing to a rate cut in June. Chances of a June rate cut by the BoE tumbled in January but have since revived as economists have realised that UK inflation is set to fall below target in the next few months and remain close to target for a year or more. Uncertainty about UK wage inflation, starting from a high base and likely to be supported by this week’s 10% hike in the minimum wage, is the big factor when arguing for delay. In the US, key inflation data has deteriorated of late and the labour market has been strong. We shall see what the employment report brings this Friday. We will be focussing on the unemployment rate, given the huge inflow of unauthorised workers from abroad. This has boosted rents which have a weight of 36% in the US CPI, over 4 times the weight in Europe and the UK. More on this in next week’s update.
The key point in this week’s update is that there is a good reason why central banks need to get on with cutting rates – to avoid tightening policy. Having kept nominal official rates on hold for 6 months or more, real rates have been rising as actual and prospective inflation has fallen. The move from quantitative easing (QE) via government bonds to quantitative tightening (QT) has exacerbated this effect.
Central banks made the mistake of thinking that they were tightening policy when they started raising rates from ultra-low levels two years ago. But real rates fell as inflation surge. They should avoid making the reverse mistake. The first cut in this cycle will attract enormous debate and controversy. It should be an easy decision and it is the pace of subsequent cuts that is more problematic.
