Bailey signals rate cuts still coming despite US inflation comeback
No major fault lines in the global economy, yet the world faces its greatest threat since the Cold War
‘There’s more demand-led inflation pressure in the US than we’re seeing. The dynamics are different’
ANDREW BAILEY has signalled that UK interest rates remain on course to fall in the coming months amid fears that stubborn inflation will force the US to delay rate cuts.
The Bank of England Governor said he saw “strong evidence” that inflation was continuing to come down in the UK, despite the resilience of the British jobs market. He said at the International Monetary Fund (IMF) spring meetings in Washington: “Our judgement with interest rates is how much do we need to see now to be confident of the process?” Mr Bailey’s comments came as the chairman of the US Federal Reserve raised doubts over its ability to reduce rates this year, warning that borrowing costs were likely to remain higher for longer because of persistent inflation.
Speaking at an event in Washington yesterday, Jerome Powell said: “The recent data have clearly not given us greater confidence and instead indicate that it’s likely to take longer than expected to achieve that confidence.”
Mr Powell said higher borrowing rates needed “further time to work” because of the strong US economy.
The Fed chief vowed to maintain rates at their current range of 5.25pc to 5.5pc for “as long as needed”. The comments from the two central bank chiefs will fuel speculation that the Bank of England will cut before the Federal Reserve. Mr Bailey said the factors driving inflation – which today’s figures are expected to confirm eased to 3.1pc in March from 3.4pc in February – were very different in the UK and Europe compared with the US.
He said: “I think there’s more demand-led inflation pressure in the US than we’re seeing. So I think the inflation dynamics are different.”
Jeremy Hunt, the Chancellor, told Bloomberg during a visit to New York that the period of high inflation in the UK was “well and truly behind us”. Mr Bailey’s comments came after stock markets had closed in Europe, where fears about delays to US rate cuts and worries about conflict between Israel and Iran triggered a steep sell-off.
The FTSE 100 suffered its worst day in nine months, tumbling 1.82pc. European markets also suffered falls of more than 1pc. Hopes of multiple rate cuts in the US this year, which would fuel global growth, have faded after strong economic data. The IMF said yesterday that financial markets had become too complacent about the speed and magnitude of expected rate cuts, noting that investors had already been forced to pare back expectations this year.
The IMF said: “In economies still experiencing persistent and above-target inflation, central banks should not prematurely ease to avoid having to backpedal later.”
US inflation stood at 3.5pc in March, up from 3.2pc the prior month and higher than economists had forecast.
High interest rates weigh down shares as companies’ borrowing costs rise and the cost of capital increases, while equities also have to compete with higher returns on other investments such as bonds or cash. Trevor Greetham, head of multi-asset at Royal London, said investors were “swinging between concern over a broadening Middle East conflict and worries that stronger US growth and/or higher core inflation could make it difficult for central banks to cut interest rates as much as previously hoped”.
Markets began the day on the backfoot after General Herzi Halevi, Israel’s army chief, said the country had no choice but to respond to Tehran’s barrage of more than 300 missiles.
Heightened tensions prompted easyjet to scrap flights to Israel for the whole of the summer season.
Just as financial markets were beginning to believe they had again dodged the bullet, along come the Israelis to insist that the restraint being urged is for the birds.
Tehran had apparently thought the matter settled after the weekend’s drone and missile attacks, with honour restored. This is looking far from the case. Escalation looks more likely than de-escalation, potentially drawing Israel’s Western allies into a conflict they do not want, still less one they can afford.
Stock, oil and bond prices have responded accordingly, but perhaps the more remarkable feature of the reaction is quite how muted it has been, so far at least.
The world is a more dangerous place today than at any stage since the Cold War, yet markets are a picture of insouciant unconcern, bordering on outright complacency, with valuations stretched to breaking point. Why so? One explanation is that, however bad the skirmishing gets, reason will eventually prevail.
In war, it’s always unwise to bank on the final triumph of reason over vengeance, but there it is. Markets want to believe in happy endings.
It’s also fair to say that, despite the increasingly murderous turn of events in world affairs, so far it hasn’t floored the global economy.
Putin’s invasion of Ukraine has pre-conditioned us into thinking localised wars can be fought without undue economic damage.
Weaning Europe off its dependence on Russian gas has proved painful and costly, but not impossible, and it triggered only the mildest of recessions. Western economies have proved surprisingly resilient.
Similarly with last week’s recalibration of interest rate expectations, which might also have caused markets more than just the passing wobble actually experienced.
Again, the remarkable resilience of Western economies in the face of much higher interest rates has conditioned markets to think they can withstand almost anything the monetary authorities can throw at them.
In the past, tightening cycles of such speed and size would have caused a deep recession, with strongly rising unemployment to match. There was no such contraction this time around. Western economies have in general defied predictions of deep recession and/or stagflation.
News that inflation is proving rather stickier than thought has therefore been like water off a duck’s back.
The “last mile” of the disinflationary process, as the International Monetary Fund’s Tobias Adrian called it in a blog to coincide with the IMF’S spring meeting this week, is proving bumpy, but it should also be digestible.
By this he means that short-term disappointments, such as last week’s worse-than-expected US inflation report, shouldn’t unduly disrupt the fund’s central forecast of a soft landing in the global economy.
The sort of cracks we see opening up in the financial system – whether caused by deteriorating geopolitical conditions or excessive debt – are, in other words, not yet of sufficient magnitude to cause investors and traders to run for the hills.
Markets were in any case getting ahead of themselves in thinking interest rates would fall rapidly from here on in. In correcting their expectations, they have merely re-aligned themselves with what central banks had previously flagged as the likely trajectory.
Nothing much to see here, then. Would that it were so. Scratch the surface, and there’s more than enough to set alarm bells ringing. The sort of very low volatility we see in financial markets today can be a signal of storms to come. Stability breeds instability.
Recent wobbles may be no more than bumps in the road, but as the IMF highlights in a series of reports to accompany its spring meeting, they are also symptomatic of fault lines in the global economy that threaten to erupt unchecked at any time.
Increased geopolitical risk is only the most obvious of them. Rising superpower rivalry has coincided with a growing number of regional proxy wars. Slow growth, meanwhile, finds the global economy awash with debt, both public and private, and no apparent way beyond inflation and/or default of paying it off.
Higher interest rates, moreover, steepen the challenge for governments in servicing the debt, and severely constrain the scope they have for appealing to voters with tax cuts and better public services.
This, in turn, is likely to prove politically destabilising, undermining the centre ground in politics and promoting the extremes. Slow growth and high debt are in other words progressively poisoning democracy.
Fiscal buffers are exhausted, with governments struggling to address elevated debt to GDP ratios. Many governments are just one more economic shock away from disaster.
It’s true that regulators have got better at responding to systemic risk. The banking system is far more robust than it was at the time of the financial crisis 15 years ago, with much bigger capital and liquidity buffers.
Resolution is also much improved, as we saw in the failure of Credit Suisse last year, when there was no wider fallout. Timely action by the Bank of England, meanwhile, succeeded in containing the harm from the liability driven investment (LDI) debacle. It did for Liz Truss, but more broadly based damage was avoided.
All the same, there is a growing sense of the cracks being plastered over, and an evident lack – without much improved economic growth – of long-term fixes.
Nor is it just Western economies. China’s debt-induced property crash has caused a sudden stop in housing starts comparable to the one that engulfed the US during the Global Financial Crisis.
Beware of taking comfort from China’s economic dysfunction. With poor little Taiwan in mind, it is in just such circumstances that nationalistic autocracies are at their most dangerous. This would be geopolitical instability on steroids.
Don’t bank on an artificial intelligence induced great leap forward in productivity coming to the rescue, either.
According to Jamie Dimon, the combative boss of JP Morgan Chase, the number of attempted hacks on the financial system has already reached 45bn a day. So far they’ve caused only minor damage and financial loss. But just think of what AI might do once in the wrong hands.
Eventually, the attacks might overwhelm the defences, causing backbone financial infrastructure such as payment systems to crumble under the pressure.
Virtually all money is digital these days; the effects would be catastrophic.
This kind of financial armageddon may be thought of as no more than a tail risk, but so too back in the day was the possibility of a global pandemic.
There’s an old joke about the IMF that, if you think the opposite of whatever the fund is forecasting, you’ll be broadly right. It’s a little unfair, because on the whole it is not bad at identifying potential weaknesses and threats. Yet right now, the central forecast is for a soft landing. Make of it what you will.
‘Markets were getting ahead of themselves in thinking interest rates would fall from here on in’