To cut or not to cut that is the question

Ahead of the Fed later today and the Bank of England tomorrow, both central banks have been given reasons why they could justify not cutting interest rates. A selection of US economic data in the last 24 hours has reaffirmed the view that the US economy continues to chug along quite well. The flash composite PMI rose to 56.6 in December from 54.9 in November, while expectations for future growth in activity improved to the highest level since June 2022. According to economists, this would indicate the US economy will continue to grow around 3% in the 4^th quarter, and estimates for the 3^rd quarter may also be revised upwards tomorrow. Americans went out and bought more cars last month, leading to a rise in retail sales; overall, Pantheon macro research believes the 0.4% increase in the control measure of sales also suggests that underlying consumer demand retains a lot of momentum, they also question how much longer that momentum lasts. Having said all that, I noticed that the Citi economic surprise index, which measures economic data against expectations, has been on a downward trend in recent weeks, as has the broader US stock market in recent days.

The headlines for the UK were taken from the monthly employment report, reaffirming that wage inflation remains an issue for Andrew Bailey. Wages grew 5.2% in October, up from 4.8% in September. Again, according to Pantheon Macro and in contrast to some of the and possibly some other indicators such as the monthly services PMI, they believe the Labour Force Survey continues to indicate a resilient employment market. The unemployment rate remained steady at 4.3%.

The monthly UK inflation data came out this morning, and it was pretty much as expected. The annual inflation rate rose to 2.6% from 2.3% in the previous month. The core rate, which excludes food and energy, was a tad higher than the market expected, but not by much. Ms Reeves will, at least this morning, breathe a sigh of relief that unlike many of the recent economic headlines, this one is in line with expectations. Will this data encourage the Bank of England to cut rates tomorrow? Unlikely. The MPC have a difficult decision to make between supporting growth and, at the same time, taming inflation. Real wages growing over 2.5% should, in theory, support consumption but will do nothing to tame inflation, which is probably what the Bank of England will conclude.

The market expects the Fed to cut later today and does not expect the Bank of England to follow tomorrow. It is hard to tell what the market would do if the Fed held rates the same. Would it be seen as the Fed being more confident in the economy’s outlook or more hawkish in the inflation outlook? Much would probably depend on the accompanying statement. The real risk is the Fed cut tonight; going forward, inflation remains sticky, and they are put into a position where they have to raise again sometime in 2025.