For most of this year markets have been attempting to front run the timing of when the Bank of England and other central banks are likely to start cutting their benchmark interest rates.
This hare started running in the aftermath of last month’s Federal Reserve rate meeting when chairman Powell said that the FOMC had discussed the prospect of rate cuts at the meeting, and in so doing undermined the narrative he had set out only 2 weeks before that rates would need to stay higher for longer.
Having let that genie out of the bottle central bankers have been attempting to put it back in to little effect to the point that markets have been pricing in rate cuts as soon as March.
This was always a remote prospect, however in acknowledging the possibility that rates may well come down sooner rather than later markets did what markets always do by pushing the envelope and doing the monetary policy equivalent of what kids do on a long journey by asking consistently “are we there yet”.
This means markets then overreact to every single nuance when it comes to economic data on inflation, wages, and unemployment.
We’ve already seen that effect in the various economic numbers since then on both side of the Atlantic, with yields considerably lower now than they were just before Christmas loosening financial conditions in the process.
Since Powell spoke a month ago US 2-year yields have fallen 4.7% to 4 25%, while UK 2-year gilts have dropped from 4.6% to 4% although we have managed to reverse almost half of that decline since the start of the year, with 12 points of the rebound coming today in the aftermath of today’s December CPI release.
The last few days has seen central bankers double down on pushing back on early rate cuts and the message now appears to be getting through, with equity markets retreating from their recent peaks, all the while we’re seeing inflation numbers that are slowing but aren’t slowing quickly enough.
There is a sense that markets are looking at the deflation taking hold in China and assuming that it’s only a matter of time before it manifests itself here in the UK as well as Europe and the US.
If you look at the PPI numbers it would appear it already has, however that isn’t the problem the Bank of England and ECB are wrestling with.
The problem isn’t goods inflation but services inflation which still looks sticky as shown by today’s services CPI numbers which edged higher to 6.4% in December, and while wage growth has slowed to 6.6% it is still high by historical standards.
The ECB has expressed similar concerns although wage growth in the EU is lower at 4%, as is headline CPI, but nonetheless this stickiness in prices is likely to make both central banks overly cautious when it comes to hinting that rate cuts are coming imminently.
This morning ECB President Christine Lagarde navigated a middle ground on the prospect of rate cuts in 2024, steering a course between Austria’s Holzmann who said he didn’t see rate cuts in 2024 to France’s Villeroy who suggested a rate cut was probable, with the timing being open.
Today’s UK inflation numbers serve to reinforce the challenge facing the Bank of England in returning inflation to target and show that the process is unlikely to be linear, with markets pushing back the timing of the first cut to the middle of the summer.
Q1 was never a realistic probability even if you believe, as some do, that we could see UK inflation fall to the Bank of England’s target of 2% by the beginning of Q2. Even if that were to happen, we would have no certainty of that until May when the April data is released which means the possibility of a May cut is ambitious.
The only debate now is not whether we see rate cuts this year, it is when we see rate cuts, which means as far as mortgage rates are concerned there is unlikely to be much of a short-term effect to today’s inflation numbers.
As far as mortgage rates are concerned the destination hasn’t changed, rates are heading down, the discussion that markets are having is over timing, and today the already remote prospect of an early rate cut diminished further, pushing both sterling and UK yields higher.
In just over 2 weeks' time the Bank of England will set out its latest projections for the UK economy in 2024. Today's economic data will mean that they are likely to remind the markets of the "Table Mountain" approach outlined by Chief economist Huw Pill at the end of last year, and that while rates will come down eventually it may take longer than people would like.
It will also be interesting to see if the 3 hawks on the MPC revise their calls for further rate hikes and decide to vote with the majority for no change.
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