Weekly Market Update – 20 January 2020

UK MONETARY POLICY

There has been a dramatic shift in the outlook for interest rates over the last few days. A week ago, prices in the futures market reflected a 10% chance of a 25 basis point cut when the Monetary Policy Committee (MPC) meets at the end of the month. A few days later that  probability had rocketed toward 70%. Two trends facilitated that increase.

The first came in the form of a series of comments from members of the MPC suggesting that they were ready to vote for a reduction should incoming economic data deteriorate. There’s nothing particularly newsworthy in that regard, that’s pretty much what you’d expect – especially from those (Michael Saunders and Jonathan Haskell) that had already voted to cut rates at both the November and December meetings. But the market was alerted by similarly dovish comments from two more policymakers (Gertjan Vlieghe and Silvana Tenreyo), bringing those we know to be inching toward a cut to a total of four of the nine rate setters.

The second trend was represented by the aforementioned deterioration in economic data. First, we learnt that gross domestic product shrunk by 0.3% during November. That was a surprise to those of us with consensus views expecting a more moderate decline. Then came an equally unanticipated fall in the pace of inflation during December, wrongfooting the consensus again. Indeed, news of a fall in the headline Consumer Price Index from 1.5% in November to 1.3% more recently was accompanied by a sharper slowdown in core inflation, this time from 1.7% to just 1.4%. As if that wasn’t bad enough, the Office for National Statistics also estimated a fifth consecutive monthly decline in retail sales, marking the longest period of stagnation for the sector in a record that stretches back to 1957.

We have some sympathy with those likely to vote for a cut in Bank Rate. The data has been awful and, with rates already low, the Bank will be keen to leverage what little room it has by moving sooner rather than later.

But we’re yet to be convinced that a rate cut is warranted at this stage.

The data being released now pertains to a period of parliamentary paralysis, peak Brexit uncertainty and, ahead of the general election, the potential for another hung parliament and/or a Marxist Chancellor of the Exchequer. Contrast that with a strong (and united) Conservative majority with a clear timetable for Brexit and an inclination to add fiscal stimulus to pre-existing, highly-accommadative monetary policy. There is, at least in our minds, a world of difference.

Still, we think we can count on Haskell and Saunders to vote for a cut, and it seems likely that Vlieghe and Tenreyo will too. Whether we get a fifth member to bring the majority onside is dependent on the data between now and then. It’s going to be a close run thing either way.

Still, we are only talking about the potential for a 25 basis point move. So far as we can tell, market participants are not expecting any parallel bond purchases or other policy measures that might signify a more aggressive shift. In that sense, we are currently in a low inflation, low interest rate environment and that isn’t going to change soon.

Looking beyond the immediate future, we’re increasingly optimistic for the prospects of both the UK economy and the domestic stock market. If Blighty and her fleet of enterprises can maintain forward momentum, however slow, through the turmoil of 2019, she can certainly do so in the calmer seas of 2020.

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