U.K. Inflation Slowdown Ramps Up View a Rate Cut Is Imminent

LONDON (Capital Markets in Africa) – The path to a Bank of England interest-rate cut as soon as this month became clearer on Wednesday after inflation unexpectedly slowed to a three-year low.

The pound fell and traders increased bets that policymakers would reduce rates on Jan. 30, as the shock reading reinforced speculation fueled by dovish comments from BOE Governor Mark Carney and others in recent days. Less than an hour earlier, policymaker Michael Saunders, who’s been voting for lower rates, said the U.K. economy needs an injection of stimulus to avoid a prolonged period of below-target inflation.

U.K. consumer prices rose 1.3% from a year earlier, the least since November 2016, while the core rate also declined. Headline inflation has been below the BOE’s 2% target since August and economists expect it to continue to undershoot until at least the middle of next year, thanks in part to the appreciation of sterling in 2019.

Expectations of a rate cut have rippled through markets, pushing the pound down almost 2% since the start of the year. The currency fell further on Wednesday, dropping 0.2% to $1.2995.

Traders are now pricing in a more than 60% chance of a cut in January, up from 44% on Tuesday. A move by May is now almost fully priced in.

A key date in the debate over the rate-cut timing is Jan. 24 when Purchasing Managers Indexes will provide an overview of the economy at the start of 2020.

In a speech on Wednesday, Saunders said that a sluggish economy and evidence of a weakening labor market will likely lead to a longer period of subdued growth. That would create a disinflationary, and persistent, output gap, a risk warrants a “relatively prompt and aggressive response.”

Still, the National Institute of Economic and Social Research said the dip in inflation should be temporary, predicting price growth will settle around the central bank’s target in the coming year. The BOE will publish fresh forecasts on growth and inflation alongside its next policy decision, which will provide more clarity on the outlook.

What Our Economists Say:
“We’re skeptical that the December inflation data will tip the balance on the committee in favor of a rate cut. Today’s figure was a little below the BOE’s November forecast for the month of December (1.4%) though the figure meant the average for 4Q was in line with the Monetary Policy Committee’s November outlook.” Dan Hanson, Bloomberg Economics

Saunders is one of two dissenting voters on the BOE’s nine-member Monetary Policy Committee. He’s been calling for an immediate 25 basis point rate cut since November, citing downside risks from a weaker global outlook and from more persistent Brexit uncertainties affecting corporate and household spending.

 “If we defer easing near term and, in the event of persistent economic weakness, face the need for greater easing later on, then risks of a low inflation trap — which would certainly not be a benign outcome — would rise,” Saunders said.

In response to questions after the speech, Saunders said that U.K. data currently justify a rate cut and the BOE has the tools to boost growth.

That view appears to have been gaining traction with his colleagues. In his first major speech of 2020, outgoing Governor Carney said the MPC has plenty of firepowers to aid the economy if necessary.

Policymaker Silvana Tenreyro followed by saying she may support a rate cut in the next few months if sluggish global growth and Brexit uncertainty persist. Another member, Gertjan Vlieghe, said he’d need to see an improvement to justify waiting to cut.

Saunders warned that Brexit risks will persist in 2020 as the U.K. negotiates its future relationship with the European Union. He also dismissed the possibility that moving too quickly to cut rates raised the possibility of a policy mistake.

“Of course, it is possible that we cut rates now and then find that the economy rebounds and renewed tightening is appropriate, say a year from now,” Saunders said. “I don’t think such a quick reversal is likely, but it is not inconceivable. I would not regard such a reversal, if it occurs, as a policy failure. It would be a benign outcome: monetary policy would have helped underpin the pickup.”

Source: Bloomberg Business News