Steven Andrew provides an update on when the expected Base Rate cut is likely to happen
We’ve reached a critical point in the UK interest rate debate. After the first half of the year which was characterised by dramatic swings in the market’s interest rate expectations, financial markets now believe that the point of Monetary Policy Committee (MPC) action is at hand.
The consensus says the Bank of England will lower the repo rate to 4.50 per cent in August then to 4.25 per cent in November. Our own view is that we’ll still have to wait until November for the first move.
The latest views of the MPC will be available next Wednesday with the publication of the minutes of the July policy meeting. Unless these minutes act to reign in market expectations we can probably assume that our timing is wrong and that rates will be lowered a fortnight later.
Of course, from the economy’s perspective, a month or two here or there doesn’t matter very much. Timing is important however to the market’s perception of where the UK economy sits in the cycle and the consequence for rate policy further out.
The delivery of an August cut endorses the market’s new-found view that the fundamentals of the UK economy have shifted materially over recent months to the extent that the Bank of England has been shocked into action.
Such a move would likely result in a yet more aggressive easing profile being reflected in the curve, with the Bank seen embarking on a rescue operation to save the UK consumer.
Market over-reaction
But as we’ve been stressing over the past few weeks, there has in our view been an over-reaction to economic newsflow in the UK with the greater likelihood being that the majority of the MPC still want to wait and see.
Our case is based upon the notion that the overall weakness in consumption has been distorted by a sharp drop in spending on durable goods.
Consumption of services by the personal sector is still running at respectable rates of growth. The current downturn still compares favourably with the more dramatic setback suffered in the early 1990s.
As Mervyn King, governor of the Bank of England, has pointed out recently, the resilience of services consumption might suggest some correction in spending on durables is likely in the coming months.
Indeed, as recent retail sales data have shown, the steady rise in household mortgage growth has once again provided a reliable indicator of spending on household goods, which has been on an improving trend since March.
Of course we are still bearish on the UK consumer for the coming year as a whole as the pressure from an easing labour market gets exacerbated by tighter fiscal policy. But for the time being it still seems to us that solid household income growth will deliver a somewhat better than expected second half of the year than is currently priced into the market.
Key developments this week
US economic data continues to be consistent with an economy growing at a robust pace, countering the very weak signals that fueled the pessimism of a month ago. Indeed, the recent up-tick in the ISM, which was mirrored in PMI gains across the globe, has now encouraged some to suggest that lead indicators may have troughed. We disagree with this notion but it is still likely to gain credence in the coming weeks as more Q2 data becomes available before being called into question by the end of the current quarter. It is not entirely surprising the market should leap to the opposite extreme rather than accept the more probable, but more boring, reality that economic surveys and data were exaggerating the genuine weakness of demand a few months ago and this process is now correcting.
Recent indicators of industrial activity across the Euro Area have shown surprising strength for an economy supposedly on its knees and a Central Bank being pressured to cut interest rates. This week’s business survey release from the Banque de France augmented the gains already seen in surveys throughout the region over the past month, from France’s own INSEE report to the German IFO survey and the broad Euroland PMI manufacturing index. As a consequence the pressure on the ECB to cut interest rates has all but disappeared.
Steven Andrew is an economist at F&C Asset Management plc
