Both the Federal Reserve and the Bank of England (BoE) have made their latest pronouncements on interest rates. At the turn of the year, this week’s meeting was deemed to be the one at which the Fed would make the first of six rate cuts this year, but the chances of that happening have long since evaporated.
As was the case in early 2023, when investors thought rates would peak as the calendar turned, the new year has brought a reality check for those who got carried away with Christmas cheer over the holiday period. The first Fed cut is now expected in June or July, and market expectations are belatedly in line with the central bank’s own. At the time of writing, this amounted to three cuts in 2024.
There are two things to draw from this outcome. The first is whether the timing of that initial cut matters all that much to investors any more: the S&P 500’s end-of-year rally was, in part, attributed to rate-cut euphoria, but the index has risen another 9 per cent year-to-date even as those expectations have been reined back in.
There are growing concerns that some form of re-inflationary pressure is evident in the US, but this is arguably a good news story, and may explain shares’ latest rise: it reinforces the ‘soft landing’ narrative that many still doubted at the end of last year.
Either way, this trend points to another lesson to learn from the events of early 2024 – one that hits closer to home. At the end of December, investors thought the BoE would also make six rate cuts this year, albeit it was tipped to begin in May rather than March. Traders and the central bank now suggest the first cut will be as late as August, with just one or two more to follow in 2024.
BoE policymakers, like their peers across the Atlantic, have reason to be cautious: inflation proved stickier at the start of this year, real wage growth is returning, and even the housing market is perking up.
The latest data, however, confirmed that the consumer price index (CPI) inflation uptick was a blip rather than a reversal of the trend. Wednesday’s data showed annual price growth fell slightly more than expected to 3.4 per cent in February, bolstering those who predict the headline rate will be at the 2 per cent target as soon as April. Domestic inflation may still be higher than in the US, but for now disinflation is proving harder to come by across the Atlantic: US inflation ticked up unexpectedly from 3.1 to 3.2 per cent last month.
The thing to remember is that the UK economy is not the same as the US. Statistically speaking, it is closer to Europe’s. Germany, like the UK, is effectively in a mild recession. All else being equal, that suggests the BoE should be aligned more closely to the European Central Bank (ECB) than the Fed. And the ECB is sounding more dovish; policymakers are now talking openly about a move in June.
All this may come out in the wash. Central banks may ultimately cut rates at more or less the same time, much as hiking cycles are more or less aligned, too. Wednesday’s data opened the door for the BoE to be more dovish during the Thursday meeting. But there’s always a risk, where monetary policy is concerned, that central bankers wait for the Fed to go first.
The BoE, to its credit, was the first to make the move when it came to hiking rates, back in December 2022 – albeit many thought it was too late to that pivot, too. It may have to act first again, because the difference between US and UK inflation figures could become starker in the months ahead, in part because of composition effects: housing accounts for a much larger proportion of the US data, for instance, while in the UK, base effects from fuel bills will help the headline rate fall in April.
If UK inflation does decline more slowly than expected from this point onwards, that will arguably be good news, prompted by the economy improving faster than many expect. Even so, current trends suggest the BoE has much more room to manoeuvre.
Base rates are not heading back to zero, but all else being equal, there is an argument for them to start moving closer to a hypothetical neutral rate. This would not be an irreversible move; nor, given the data we have seen so far this year, would it be unwarranted.
