There’s no doubt that central banks are in rate cutting mode. The European Central Bank (ECB) are set to cut rates this week, the US Federal Reserve (Fed) will likely start their rate cutting cycle next week and the Bank of England (BoE) will either cut when they meet later this month or leave it until the following meeting. The direction is not the issue, it’s the speed and scale. By year end, the market is pricing in a total of 45 bps from the BoE, 62 bps from ECB, and a whopping 113 bps of cuts from the Fed. By this time next year, markets expect official rates to be just over 3.5% in the UK, 3% in the US and just 2% in the eurozone. That all adds up to a lot of rate cuts ….so the question is whether markets will be disappointed.
Let’s start with the US. Last week’s employment report showed job growth was slowing, continuing a trend that has been in place for a while. But that reflects reduced hiring rather than increased firing together with a slowdown in immigration. Taking account of other data suggests that the US economy is still growing steadily. This week’s data should show a fall in headline inflation and although core inflation is likely to be unchanged on a YoY basis, the last 3 months will have seen core inflation running below 2%. With wage inflation slowing and oil prices falling on increased supply, the outlook for inflation is good. But we need everything to go right if we are to get the cuts priced in for the US this year. Unless the Fed cuts by 50 bps next week, that number will have to come down. And then of course, there’s the prospect of a Trump presidency with a steep rise in tariffs.
Over in Europe, growth has been anaemic, recent data show a big fall in wage inflation and inflation is close to target. And the European Commission is putting pressure on governments to tighten fiscal policy. Given this background, the rate cuts priced in seem reasonable.
The UK has the smallest number of rates cuts priced in suggesting that the UK will have a level much higher than in Europe and a little above that in the US next year. There is a definite possibility that the BoE might deliver more cuts than currently priced in.
The precise path of rate cuts is crucially important for bond markets. Equities should simply enjoy the background of continued growth and falling interest rates. Mind you, there’s a lot of optimism priced into equities too, as evidenced by last week’s weakness.
One final point, weak oil prices and strong sterling mean that the wholesale price of fuel has been falling here in the UK. That should be gradually passed onto lower prices at the pumps. But don’t run on a low tank for too long: there’s a distinct risk that we get a hike in fuel duty in Rachel Reeves’ first Budget on 31st October.
