Weekly Update - One dove does not spring make
This week the US Federal Reserve (Fed) and the Bank of England (BoE) followed the European Central Bank (ECB) in indicating that while they are mulling rate cuts, they won't be starting until they have enough evidence inflation is moving towards the target. Central bankers want to see more data and are apparently willing to wait for spring before embarking on the rate cut cycle. These cuts may, in our view, prove less radical than markets are discounting, with just three in 2024.
The Fed: not so dovish. To no-one's great surprise, the Fed kept monetary policy on hold this week. However, there were big changes in terms of communication in its statement. They cut out the warning that further rate hikes might be necessary but then added rates would not come down until they have greater certainty that inflation is “moving sustainably toward 2%”. The Fed is thus sending a clearly accommodative or “dovish” message, confirming that a rate cut is now on the way but is also signalling that market expectations of a rate cut as soon as March are too optimistic. Markets duly scaled back the probability of a quarter-point cut in March. However, 25bp rate cuts for early May and mid-June remain well-priced in, despite the drop in probability following up the release of the stronger-than-expected US employment report (Chart 1).
The BoE: sitting on the fence. At the Bank of England, the vote was anything but unanimous. Six voted for no change, one for a rate cut and two for an increase. Ignoring its two hawks, the BoE removed its warning of a possible additional tightening from its statement, endorsing the widespread perception that the rate hike cycle is over. However, using near-identical wording to the Fed, Governor Andrew Bailey said the BoE was not yet ready to cut rates and would wait until inflation was not only back to target but set to stay there.
Rate cuts this spring, but a slow path thereafter. In our previous weekly (here) we mentioned that euro area inflation may take time to get back to its 2% target as base effects, particularly on energy, and weak productivity growth held it back. This would restrict the ECB's room for manoeuvre. The BoE is in a similar bind, particularly as British inflation was, on average, at least one percentage-point higher than the euro area’s in 2023.
But the story is different for the Fed. Some measures of inflation are already at target, notably personal consumption deflator. Moreover, productivity gains have bounced back from its low in late 2023 (Chart 2). Which means the Fed's problem is not so much a struggle to get back to it inflation target but rather a robust economy – GDP grew by an annualised 3.3% in Q4 – which continues to power healthy levels of job creation (see thereafter). The Fed therefore has no need to cut hard and fast. The US economy looks solid enough to cope with continued tight monetary policy.
Overall, we think, following a first rate cut in spring, all three main central banks are likely to step rates down at a gradual pace. We expect three cuts this year by the Fed, ECB and BoE. This compares to the five to six discounted by the markets for the Fed and the ECB and four for the BoE.
In the highlights of the week, we chose to talk about the European growth figures as well as the American job market data :
Euro area GDP growth was flat in Q4 2024, defying expectations of another 0.1% contraction similar to that of Q3. This less-than-spectacular achievement was driven by strong figures from Spain (0.6% growth rather than 0.2% expected) and Italy (0.2% rather than expected stagnation) while France stagnated as predicted and Germany shrank by 0.3%. There were also positive contributions from smaller economies including Portugal (0.8%), Belgium (0.4%) and Austria (0.2%) but not Ireland which declined by 0.7%. Meanwhile, euro area inflation eased in January but by less than markets had expected, from 2.9% to 2.8% rather than 2.7% expected..
January's US employment figures gave another evidence of the resilience of the US economy, with 353,000 job creations, well above economists' expectations of 180,000. The unemployment rate was 3.7%, unchanged from the previous month and below the market's expectations of 3.8%. The strength of the US labour market is also benefiting workers, who saw their average hourly earnings rise by 0.6% over the month (4.5% year-on-year), up from 0.4%