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“It's a milestone“

Bob Dylan, I'm Not There

Last week, we discussed what we described as a milestone in the monetary policy trajectory of the Bank of England - The key evolution was the downward revision of the inflation projections across the forecast horizon. With the projections - conditioned on the market-implied rate path - lowered to 1.9% in Q2 ‘26 and just 1.6% in Q2 ‘27. Such a significant downside miss at the forecast horizon is a clear dovish signal for policy. A point emphasised by Governor Bailey in the press conference where he stated that ”rates may fall more sharply than markets expect”.

Dissenters as leading indicators?

Also notable at the May meeting was the dissent of Sir Dave Ramsden, who joined Swati Dhingra in voting for a 25bp rate cut, arguing the need to become less restrictive now to allow a smooth policy transition given the lags in transmission. The dissenters also argued that as demand, labour markets and wage growth ease, the risks to the inflation outlook are to the downside. In short, the dissenters are aligned with a point we have made a number of times in this blog, that as inflation declines, real rates move higher, and thus, policy becomes more restrictive (despite remaining unchanged). In this regard we see Dhingra and Ramsden not so much as dissenters, more as leading indicators of the policy trajectory.

The notable reference from the Bank’s Agents survey that “contacts are unsure as to the reason” for the weakening in underlying demand is also important from our perspective as we have also noted on many occasions our view that the underlying strength of the UK economy (and the US economy for that matter) is not as strong as the headline data suggest - the drivers of inflation not as robust or sustainable.

Not ruled out, nor a fait accompli

Ultimately, from our perspective, the direction and intent of monetary policy are clear. However, the timing and cadence of the rate-cutting cycle in the UK is a little more moot. Following the Bank of England and the slightly weaker employment data at the start of the week, current market pricing for rate cut expectations is split. Indeed, the current market pricing for the June meeting is 15bps or a 60% chance of a 25bp cut - you could say this is the numerical representation of Bailey's “not ruled out, nor fait accompli” message. At least part of the markets’ reluctance to price June fully comes from the fact that the August meeting is an MPR (Monetary Policy Report) meeting, and it is likely that given the choice, the MPC may wish to begin the cutting cycle at a meeting with updated economic projections

Inflated Expectations

This week, the market focus swung back to the US. To all intents and purposes the current global macroeconomic configuration is essentially a one-factor world - The US monetary policy trajectory - as has been demonstrable in the market response to this month's payrolls and CPI for global yields, credit, equities and, notably, the USD. The CPI print was broadly in line on an annual basis, but there were some notable compositional themes in both CPI and PPI prints.

The PPI is relevant in that there are a number of subcomponents that feed through into the Fed's preferred (and thus most policy-relevant) PCE inflation measure - These components (medical care, airfares and brokerage services), in aggregate, had a more disinflationary feel in April, notably through the sharp decline in airfares.

The CPI also had a disinflationary composition with primary rents rising at their lowest level in around two and a half years, with much of the outstanding strength remaining in the lagged catch-up in OER (Owner Equivalent Rent - an odd construct in itself and not at all reflected in the European HICP methodology. Indeed, on an HICP basis, US inflation would likely already be at target) and used car insurance (it is hard to see the relevance of higher car insurance costs on the monetary policy reaction function).

The Long & Short of it

Recent months have seen heightened volatility and uncertainty - dominated by the debate around the US monetary policy path. The Q1 data outperformed expectations in the US to such an extent that after pricing close to 150bps of rate cuts in 2024 at the start of this year, US curves implied a significant probability of a rate hike in the US during the course of this month. An incredible U-turn.

However, we have argued for a long while now that we see continued disinflation and growth moderation in the USD as the dominant global macroeconomic driver. We continue to argue that the Fed policy reaction function remains asymmetric and that the growth inflation tradeoff will warrant rate cuts in the US through 2024 and 2025. We believe that last week was a milestone for monetary policy in the UK, this week may well prove an inflation milestone in the US. However, it seems, like Bob Dylan, the market is “Not there”... yet.

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