What are central banks telling us about interest rates?

Last week saw the annual central bankers’ retreat in Jackson Hole, Wyoming. Jerome Powell, Chair of the US rate setting committee was clear and open: ‘the time has come to cut rates’, Andrew Bailey, his UK equivalent was cautious: ‘too early to declare victory’. As for the ECB, they were represented by heavyweight Philip Lane but President Lagarde did not attend and little new was said.

So where are we left? Unlike the BoE & ECB, the US central bank has yet to cut rates and clearly feel that they have to catch up. The markets agree. They are pricing in 100 bps of cuts by year end. With only 3 meetings to go that would require a 50 bps cut at one of them. That’s quite a stretch but much will depend on the next set of employment figures on 6 September. Weak numbers would give us a 50 bps cut at the meeting later that month. The unemployment rate will be the focus: it signalled recession when it was published earlier this month. I discussed this in Market Perspectives’ three weeks ago and suggested that recession was not likely. One reason was that much of the unemployment increase was due to temporary factors. If that’s correct, we should see a fall in unemployment.

Barring really weak data elsewhere in the report, that would make a 25 bps cut less likely. Overall, I do see scope for disappointment given how much is priced in for the rest of the year. But the trend is clearly set for lower US rates. The market is pricing another 123 bps of cuts next year, which would take the Fed Funds rate down to 3%. There’s definite downside on that number but, once again, there’s a lot priced in.

The UK markets have priced in just 40 bps of cuts in the Bank rate by year end. The economy here is accelerating, albeit from a low base, and fears of a big rise in unemployment seem overdone to me. Inflation has been bang on target until the latest number but is set to rise steadily from here. Household energy bills are a big factor: they will rise by 10% in October, the first increase for two years. That represents a challenge for the BoE and the government, with the latter under pressure to provide more relief for pensioners and those on low incomes.

There is good news too though: wage inflation is set to tumble on a 3-month on 3-month basis – closely watched by the BoE – as we move away from April’s 10% hike in the minimum wage.

Sterling has been the strongest major currency so far this year and that feeds through to lower prices for imported goods. And figures from the retail industry show the first fall in prices in year-on-year terms since Covid. All in all, I reckon we could get 50 bps of cuts by year end. There’s 82 bps more of cuts priced for next year, which would take the Bank rate down to 3.75%. That definitely possible but there are two-way risks.

As for Europe, markets are pricing in much the same profile for rates cuts as in the UK. Growth in Europe is anaemic and there was some really good news on wage growth last week that received remarkably little attention: it fell to just 3.5% on a yearly basis, a big decline and not far from a level consistent with the 2% target. I had been rather cautious on the outlook for ECB rate cuts but I’m now less so.

So, to sum up, markets are pricing in big rate cuts. If the US employment data are weak, they should get what they expect but the risks are for some disappointment. Over in the UK, things look okay for this year but less so in 2025. In Europe, the outlook has improved with a slowdown in wage growth. As for risk assets, fine tuning of rate expectation matters less than the strong list of positives: falling interest rates, falling inflation and continued economic growth.