The focus of investors remains concentrated on the moves of central banks. In Europe, confidence in an upcoming interest rate cut remains high, while the situation is less clear in the United States of America. Meanwhile, the Bank of England left everything unchanged as did the Reserve Bank of Australia. For the first time in eight years, there is a cut in Sweden.
Bank of England cuts inflation forecasts. Fixed rates
In line with forecasts, the Bank of England opted for the sixth consecutive time to maintain key interest rates at 5.25%. A decision, taken with a majority of seven board members against two, dictated by the still high price level, with inflation stuck at 3.2%, well above the 2% target.
The markets, in any case, seem to be pricing in a first rate cut already during the summer. “We have received encouraging news on inflation and believe it will fall close to our 2% target over the next two months,” said Governor Andrew Bailey. “We need to see more evidence that inflation will remain low before we can cut rates. interest. I'm optimistic that things are moving in the right direction.”
Within the Bank of England's Monetary Policy Committee (MPC) it voted by a majority of 7-2 to keep the key interest rate at 5.25%. Two members, however, would have preferred to reduce the rate by 0.25 percentage points, to 5%.
First time in Sweden in 8 years
The Swedish central bank has decided to cut the cost of money by 0.25 basis points for the first time in eight years, bringing the reference rate to 3.75%. Inflation is approaching the target, explains the Riksbank, while economic activity is weak. If the inflation outlook is confirmed, rates could be further cut twice in the second half of the year, in line with what was forecast in March.
Reserve Bank of Australia leaves everything unchanged
Meanwhile, the Reserve Bank of Australia kept its liquidity rate target unchanged at 4.35% and the interest rate paid on Exchange Settlement balances at 4.25%, as inflation is falling more slowly than expected. The Brazilian, Polish and Swedish central institutes will also meet this week.
Fed, cut it out!
The season of quarterly reports is coming to an end and investors continue to wonder about the moves of the Federal Reserve which is not clear whether it will proceed with two cuts or just one during the year in the wake of bright and dark macro data.
The president of the New York Fed, John Williams, assured that there will be a rate cut, but that the current level of monetary policy is still in a good position, without denying that the surprise on the latest American inflation data is a source of concern. Caution was also expressed by the head of the Richmond Fed, Thomas Barkin, according to which we still have to wait before easing monetary policy, as the risk remains that inflation in the real estate and services sectors could keep price increases high. Goldman Sachs economist David Mericle said he expects two more rate cuts this year, in July and November, after Fed Chair Jerome Powell strongly rejected the possibility of further hikes.
There are also those who have not ruled out the risk of a new rate rise. The president of the Minneapolis Fed, Neel Kashkari, commenting on the inflation trend, stated that, in his opinion, the Federal Reserve could be forced not to cut rates during 2024. “I believe that it is much more likely that we will have to wait longer than expected or than what the public is predicting right now, until we see the effects of our monetary policy.” Even a member of the Federal Reserve board, Michelle Bowman, who is not generally considered to be one of the most intransigent hawks, raised the possibility of a rate increase, “if the data that will arrive indicate that progress on inflation has stalled or is reversed”. It is important “to keep in mind that monetary policy is not on a set path. My colleagues and I will make our decisions at each FOMC meeting based on the data that comes in and its implications and risks to the outlook. While the current monetary policy appears to be at a restrictive level, I remain prepared to raise rates at a future meeting if incoming data shows that progress on inflation has stalled or reversed.”
ECB towards more cautious cuts after inflation and GDP
The eurozone economy grew 0.3% in the first quarter, much more than consensus forecasts of 0.1%. Services inflation, however, declined, but not as rapidly as expected. Nonetheless, it stood at a trend level of 3.7% in April, down from the 4% recorded in March.
What do these data mean for the ECB? First of all, the good news, explains Tomasz Wieladek, Chief European Economist, T. Rowe Price. The ECB forecast a stronger recovery in labor productivity than market consensus. This appears to be happening. Half of the weakness in labor market productivity was concentrated in the services sector. Given that growth is stronger in highly specialized service economies, higher productivity growth in this sector indicates that the ECB is able to live with wage inflation of 3-3.5%. Essentially, this is the phase we are in. The revival of productivity means that the ECB is able to proceed with rate cuts, even if wage growth does not fall below 3%.
However, inflation data is less constructive. Services inflation declined year-on-year, but less than expected. Part of this decline has to do with base effects due to the timing of Easter. The board of directors will have a figure “purified” of the distorting effects of Easter only at the end of May. So implied services inflation is a little stronger than expected.
The ECB will start cutting rates in June anyway, given the very high level of rates today. The neutral rate is also not higher than 3%. This leaves plenty of room for cuts. However, as regards the pace of cuts after June, the ECB will be guided more by actual services inflation than by labor productivity. The data makes it much more likely that the ECB will skip July and then cut two or three more times this year. A scenario of four or five rate cuts is not a possibility to be discarded this year. Overall, this data will make the ECB more cautious about the pace of rate cuts after June.
The Bank of Japan's dilemma
Apparently the Bank of Japan has finally achieved, after a long time, the coveted objective of inflation constantly at 2%, overcoming some structural problems that have afflicted the economy of the Land of the Rising Sun for decades.
Contributing to this scenario is the saturation of the Japanese labor market, where recent wage negotiations carried out by one of the main trade unions have resulted in a 3.7% increase in basic wages, the largest increase in the last 30 years. Noting these developments, the Bank of Japan finally ended the negative interest rate regime in March 2024, raising overnight rates from -0.1% to 0-0.1%, abandoning the curve control program of returns (YCC) and allowing the market to operate under more normal conditions.
Despite having sufficient room for maneuver to make gradual changes, we read in a report by JP Morgan Asset Management's Global Fixed Income, Currency and Commodities Group team, the Japanese central institution is not in a position that allows it to undertake an aggressive increase cycle and move in a direction clearly opposite to that of the other Central Banks of Developed Markets. Among all developed countries, Japanese public debt is the highest, standing at over 240% of GDP, which is more than double that of the United States. Furthermore, a question mark remains over the ability of families and businesses to cope with the increase in financing costs, after having benefited from very low rates for years.
