Global Daily – Fed on hold, but could the BoE cut?

by: Bill Diviney

FOMC Preview: In a holding pattern The Fed is widely expected to keep policy on hold when the January FOMC meeting concludes tomorrow. We expect only modest – if any – adjustments to the post-meeting statement, leaving it to Chair Powell to provide nuance to the Committee’s current thinking in the press conference. Data since the 10-11 December FOMC meeting have been mixed, with measures of domestic demand broadly solid (retail sales, services business surveys), but the export-oriented manufacturing sector and inflationary pressures (eg. wage growth) have disappointed to the downside. The Fed might also make reference to the halting of production of ‘aircraft’ (i.e. the Boeing 737 MAX) – and the indirect effects of the coronavirus outbreak in China – as factors likely to weigh on near-term growth, although if Powell mentions this he will point to these effects likely being transient (with the implication that the Fed would not respond to a slowdown on the back of this).

Our base case is that the Fed will make one more ‘insurance’ cut to interest rates, taking the target range for the fed funds rate to 1.25-1.50%, by the middle of the year. While Fed officials – even the more dovish FOMC members – currently signal broad comfort with current policy, our growth forecast is considerably lower than the Committee median (at 1.3% vs 2.0%), and we expect slower growth to prompt a change of heart over policy as the incoming data weaken. Weaker pipeline inflationary pressures could also bolster the case for more easing (see here).

Technical adjustment to IOER possible, but no monetary policy implications One piece of housekeeping the Fed might do at this meeting is to raise the interest on excess reserves (IOER) rate by 5bp, partially reversing the cuts it made to this rate in 2018-19. This is because the fed funds rate – and broader funding market conditions – are now much more stable following the start of repo market operations and T-Bill purchases. Such an adjustment was hinted at in the December FOMC minutes, and if implemented, would be a purely technical measure. (Bill Diviney)

BoE Preview: Close call, but policy likely to stay on hold – The MPC meets on Thursday in what is likely to be a very close vote on whether to cut rates. Our view has been – and remains – that the MPC will keep policy on hold given the post-election rebound in business confidence. The data has been decidedly mixed, although the weakness is mostly in the backward-looking hard data (such as November GDP, and December retail sales and inflation), while the stronger data has been of the more forward-looking variety (the Services PMI, CBI Business Optimism). Jobs growth has also been much stronger, following a period when it seemed like the labour market was entering a downturn. While we expect growth to remain subdued overall in 2020 at 1.2% (the same as 2019), the indications are that we will see a near-term bounce in growth following the convincing electoral win of the Conservatives in December.

Looming fiscal stimulus another reason for MPC caution – A further reason we expect policy to stay on hold is the likelihood of a fiscal splurge being announced at the 11 March Budget, which will come before the next MPC meeting on 26 March. Chancellor (or finance minister) Sajid Javid has already made big changes to the rules governing UK fiscal discipline, for instance allowing net public investment to rise to 3% of GDP from the previous 2% limit, and has said he sees low bond yields as a “signal to me from the market — from investors — that here’s the cash, use it to do something productive.” This paves the way for some potentially big spending plans to be announced. (Bill Diviney)