As traders prepare for the twin impacts of monetary policy decisions from the Federal Reserve and the Bank of England, economists say even if the former opts for a sharp rate cut it will not stop the latter from keeping rates unchanged this week.
Markets are pricing in a more than 60% chance that the Federal Reserve will cut its federal funds rate by 50 basis points this week from its current range of 5.25% to 5.50%. That would be the first rate cut by the Fed in more than four years.
Meanwhile, money markets have priced in a rate cut at the Bank of England at its Thursday meeting, down from 35% late Tuesday to 26% Wednesday morning, but still slightly higher than last week. Prior to this, the UK CPI annual rate in August was 2.2% as expected, the same as in July, thus supporting the need for the Bank of England to be more cautious.
While headline inflation in the UK has been at or close to the central bank’s 2% target for five months now, inflation in the services sector, which accounts for 81% of the UK economy, remains stubbornly high, rising to 5.6% in August from 5.2% in July.
Falling energy prices pushed down headline inflation, while core inflation (excluding energy, food, alcohol and tobacco) fell at a much slower pace.
UK headline inflation close to target, but services sector inflation remains high
Sanjay Raja, chief economist at Deutsche Bank, told CNBC that a more “forceful” rate cut from the Fed would not necessarily change the Bank of England’s decision this week, especially because the Monetary Policy Committee (MPC) typically approves its decision around lunchtime London time on Wednesday before announcing it on Thursday. The Fed’s policy announcement is not due until 7 p.m. London time on Wednesday.
However, Raja added, “this could have implications for the MPC’s risk management considerations, including opening the door to a discussion of the twin inflation/growth risks facing the economy, and perhaps even encouraging some members of the MPC to talk about tapering restrictive policies more quickly.”
George Lazarias, chief economist at Forvis Mazars, told CNBC on Wednesday that in developed economies, "services inflation is rising and the reduction in overall inflation is mainly due to external factors," he said.
Lazarias explained that "this means it's too early for the Bank of England and the Federal Reserve to cut interest rates significantly." Because of this, he neither thinks the Fed will cut interest rates by 50 basis points this week, nor does he think the Bank of England will cut interest rates, even to boost sluggish economic growth.
In addition, he noted that cutting rates too fast and too far could force central banks to raise rates next year, undermining their credibility and the anchoring of inflation expectations. Lazarias believes that expectations of a 50 basis point rate cut are based on bond market positioning and do not reflect the views of most strategists.
“The Fed may come too late (to cut rates), but it will set the tone for the path ahead,” he said.
The BoE initiated monetary easing by cutting interest rates by 25 basis points at its August meeting, but the split in the MPC left market participants wondering whether they had held off on cutting rates until the last minute. The MPC voted 5-4 in favor of a rate cut, with the cautious camp citing the labor market and services sector as the main reasons for concern.
Consultancy Capital Economics said Wednesday's CPI data reinforced expectations that the Bank of England would remain on hold in September and pointed to a 25 basis point rate cut at the next meeting in November. It added that downward pressure on food and fuel prices was offset by rising prices for household equipment, entertainment, culture and airfares.
The article is forwarded from: Jinshi Data