One Step at a Time as Central Banks Plot Reduction of Restrictive Rates

Exclusive insight for TMI subscribers! Northern Trust Asset Management share a monthly market commentary for treasurers.

Eurozone Market Update

The ECB Governing Council kept its key policy rates unchanged in July. This was expected, as market pricing indicated a near-zero probability of a rate change. Forward guidance from the June meeting and ECB member speeches had already signalled a pause. The press release noted that incoming data supported the ECB’s assessment of the medium-term inflation outlook. The council reiterated that monetary policy decisions will be based on the inflation outlook, underlying inflation dynamics and the transmission strength of their policy. President Christine Lagarde emphasised data dependency over ‘cherry picking’ specific data points , a crucial difference, stating that September’s decision remains open. The Flash Eurozone Composite PMI for July was lower than expected, increasing fears of economic slowdown in the third quarter and boosting investor confidence that the ECB might cut rates in September. We agree with this expectation.

_{Source: Bloomberg, data as of 31 July 2024}

UK Market Update

The BoE narrowly voted 5-4 to cut the bank rate by 25 bps to 5.00% at the August Monetary Policy Committee (MPC) meeting. Market expectations were divided between June’s “finely balanced” decision and hawkish comments from BoE Chief Economist Huw Pill. Governor Andrew Bailey voted with the majority and, surprisingly, against Pill. The MPC dismissed elevated services inflation pressures, highlighting various surveys that indicated waning price pressures. Inflation projections were revised down to 1.7% in two years and 1.5% in three years. Forward guidance also shifted from “remain restrictive for an extended period” to closely monitoring indicators like labour market conditions, wage growth, and services price inflation. During the press conference, Bailey also emphasised not cutting rates “too quickly or by too much”.

_{Source: Bloomberg, data as of 31 July 2024}

US Market Update

The Federal Open Market Committee (FOMC) left the federal funds rate and balance sheet runoff unchanged in July. A rate cut in September is anticipated, with a 100% probability of a 25 bps cut and a 28% chance of a 50 bps cut (see Chart of the Month). The statement noted job gains have “moderated” and the unemployment rate “has moved up but remains low”. On inflation, it mentioned “some further progress” towards their 2% objective, compared to “modest further progress” six weeks ago. U.S. July monthly nonfarm payrolls were lower than expected at 114,000, down from 179,000 in June, with the unemployment rate rising to 4.3% from 4.1% in June.

_{Source: Bloomberg, data as of 31 July 2024}

Looking Ahead

Despite cuts from both ECB and BoE, all three central banks are cautious about rate cuts, focusing on reducing restrictive monetary policy rather than a full easing. BoE Governor Bailey’s “too quickly or by too much” comment underlines this. Market reactions to recent inflation data may have been overblown in the U.S., with nearly three rate cuts priced in by year-end. Given the FOMC’s dual mandate for labour and inflation, we expect only two cuts this year. The BoE’s finely balanced decision highlights diverse committee views, suggesting a gradual reduction approach. We anticipate a further 25 bps cut in Q4 by the BoE and an additional 50 bps by the ECB this year. But given the focus on data, any large upside or downside surprises can change the outlook for policy rates significantly. Central banks need more inflation and labour data to confidently achieve their targets, making this incoming data crucial for our interest rate outlooks.

Chart of the Month

_{Source: Bloomberg as of 31 July 2024}

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