The Bank of England’s monetary policy decision on Thursday will be a key investor focus after the European Central Bank cut interest rates for the second time since the coronavirus pandemic and with the US Federal Reserve expected to start its cutting cycle on Wednesday.
Economists are discussing whether the data supports a back-to-back cut in interest rates after the BoE in August lowered borrowing costs — by a quarter of a percentage point — for the first time in more than four years.
Many economic indicators appear to have opened the way for further cuts. These include services inflation, which dropped more than expected in July and economic output, which stagnated in June and July.
Moreover, wage growth has continued to ease, supporting the view of declining underlying price pressures.
However, while easing, wage growth and services inflation, a key measure of underlying price pressures, are still elevated. The unemployment rate is low and economic growth was stronger than expected in the first half of the year, when the UK grew at the fastest pace in the G7.
The BoE has also signalled a cautious approach to lowering borrowing costs.
“The tone of the August meeting and subsequent speeches have made it abundantly clear that officials don’t want markets running away with the idea that this is going to be a rapid easing cycle,” said James Smith, an economist at ING.
With no new economic forecast due with Thursday’s rate decision, markets expect, on balance, that the BoE will keep rates on hold before cutting them again in November, although they still ascribe a roughly 25 per cent chance to a rate cut this time.
August inflation data on Wednesday, the day before the BoE meeting, could affect investors’ expectations.
Economists polled by Reuters expect headline CPI inflation of 2.2 per cent in August, the same as in July. Services inflation is expected to rise to 5.5 per cent in August from 5.2 per cent in the previous month.
Valentina Romei
How much will the Fed lower borrowing costs?
The US Federal Reserve will on Wednesday make its final interest rate announcement before the US election in early November.
Traders are widely betting that the central bank will choose to cut borrowing costs from their current range of 5.25 to 5.5 per cent — a 23-year high. But with just days to go, they remain divided over how aggressively the Fed will move.
The latest payrolls report offered signs of stabilisation in the US labour market, with 142,000 new jobs added in August — up from a downwardly-revised figure of 89,000 for July.
Consumer price index data this week also showed evidence of a further easing of inflation, with a reading of 2.5 per cent year-on-year for August — down from 2.9 per cent the month previously — albeit with some stickiness in housing and shelter costs.
But the Fed still faces a close call on whether to cut rates by 0.25 percentage points or a jumbo-sized 0.5 percentage points at its September meeting.
On Friday, former New York Fed president Bill Dudley said he saw a “strong case” for a half-percentage point cut, pointing to the restrictive impact on growth of rates at current levels.
Investors’ expectations have fluctuated wildly in recent months, but by the end of this week market pricing indicated that bets on a half point cut had significantly increased.
“We maintain that a quarter-point initial cut is the path of least resistance,” said Ian Lyngen at BMO Capital Markets on Friday, “although it is clear that 50 basis points is on the table and will be part of the Fed’s conversation.” Harriet Clarfelt
Will Japan raise interest rates again next week?
At its monetary policy meeting in July, the Bank of Japan raised interest rates to 0.25 per cent and scaled back its purchases of Japanese government bonds.
This was momentous, given Japan had not raised rates for more than a decade, and came far sooner than most sellside economists had expected. It was blamed, by some analysts, for the volatility that ripped through equity, bond and currency markets in the days that followed.
Investors are now assessing, ahead of next week’s monetary policy meeting, whether the August volatility has caused the still hawkish BoJ to pause, or whether it will press ahead with another move despite the risks.
The consensus view of those same economists who — mostly — did not expect a rate increase in July is that the BoJ will unanimously vote to keep rates on hold this time.
Deputy BOJ governor, Ryozo Himino, pointedly signalled in a recent speech that the central bank was still “examining the impact” of its July move, which raised the interest rate to “around 0.25 per cent” from a previous range of zero to 0.1 per cent.
Senior BoJ officials are privately using the same language, implying Japan is still treading cautiously into rate normalisation after many years of ultra-loose policy.
The data, meanwhile, is not providing a compelling argument for a back-to-back rise, say analysts.
The yen, after hitting multi-decade lows against the US dollar in July, is at its strongest since December.
Wages have been trending higher, but, said Takeshi Yamaguchi at Morgan Stanley MUFG, the pass through to private-sector service prices is lagging “and the BoJ is not in a position in which it needs to raise the policy rate hastily” ahead of the ruling LDP party leadership election and consequent change of prime minister on September 27.
Many suspect a decision to keep rates on hold will be accompanied by some signal of a willingness to do so later in the year — most likely December.
Leo Lewis
