High employment and the absence of significant economic contraction has removed pressure on central banks to cut interest rates as headline inflation falls, with the Bank of England most likely to delay while the Fed leads developed economies in cutting rates.
In the UK, Chief Economist EMEA at Columbia Threadneedle Steven Bell expects falling headline inflation to reinforce the positive impact of rising real wages and encourage consumers to reverse their current build-up of precautionary savings.
“This removes pressure on the Bank of England to cut interest rates,” he says. “Instead, it can wait for the current high pay rises to fall, likely in the second half of the year.”
The majority of chief financial officers surveyed for the latest quarterly Deloitte CFO survey expect the Bank of England to cut its base rate to 4.25% over the next 12 months.
Susannah Streeter, Head of Money and Markets at Hargreaves Lansdown also believes policymakers will be keen for more evidence that core inflationary pressures will see a sustained fall before they cut rates.
“In the US, manufacturing data indicating factories are churning out more goods has led to fresh risk-off sentiment spreading as worries brew about inflation staying doggedly above target and the Fed being potentially forced to hold off from cutting rates by as much as previously forecast this year,” she says.
Federal Reserve Chairman Jerome Powell has made it clear that the US central bank is in no rush to cut rates and manufacturing data has made the prospect of a cut in June much less likely according to the markets.
Padhraic Garvey, Regional Head of Research for the Americas at ING says inflation will have to come down again to give the Fed room to finally cut rates although he still expects interest rates to fall in June.
He also thinks the ECB will start cutting in June for a total of three cuts this year. “If core inflation comes in below 3% markets may get excited and price in more than this,” says Garvey. “However, we don’t think the ECB will be in a rush to cut faster given a recession does not seem imminent.”
Bell agrees the ECB is also likely to be wary of cutting rates until it is clear that pay rises are trending down. “Growth, inflation and interest rates trending above previous very low levels will limit the scope for interest rate cuts in Europe,” he says.
Inflation has fallen materially and is now within touching distance of central banks’ targeted levels observes Morningstar’s European Market Strategist Michael Field. “This means there will soon be no reason not to cut interest rates if indeed inflation is under control,” he says.
The most recent data from the ECB shows that the interest rate on new loans of over €1m with a floating rate and an initial rate fixation period of up to three months decreased by 11 basis points to 5.04% in February while the rate on new loans of the same size with an initial rate fixation period of between three months and a year fell by 15 basis points to 4.85%.
The rate on new loans of over €1m with an initial rate fixation period of over ten years increased by nine basis points to 3.88% and the rate for new loans of up to €250,000 with a floating rate and an initial rate fixation period of up to three months also rose, by 15 basis points to 5.44%.
Morningstar Editor Antje Schiffler notes that the ECB has historically been hesitant to make monetary decisions ahead of its US counterpart although several members of its governing council, including ECB president Christine Lagarde, have said that what counts for the ECB are its own inflation and economic forecasts.
