Lowes Magazine Issue 130

EAR TO THE GROUND

Are we there yet??

Paul Milburn, Lowes Investment Manager

expected. Whilst the cut had been expected by the market to be in March, this has now been put back to June, possibly July after the recent inflation print. In the Euro area meanwhile, inflation has fallen to 2.4%, closer to the 2% target still. Yet, the European Central Bank (ECB) are yet to move and, like others, remain data-dependent and would like to see more compelling evidence that high inflation has been defeated. Now admittedly the Swiss National Bank did catch the market by surprise and decided to reduce their key rate by 0.25% last month. But, given that inflation in these major developed economies has moved in the right direction, why are we yet to see a move by either the Bank of England, the Fed or the ECB? In part this could be due to reputation. All three were heavily criticised for not reacting quick enough when inflation was rising sharply, with some questioning if inflation would have hit the dizzy heights which were seen. They perhaps do not want to cut too early, but at the same time they will not want to be too late. History could also be playing its part here. For those of us old enough to remember, there was not one, but two inflation peaks seen in the US during the 1970’s and early 1980’s. When we map the current inflation cycle with that cycle, you could argue that there is an uncanny resemblance. Whilst we do appear to have potentially entered a new inflation regime, that of course does not automatically mean that history will repeat itself. There were very specific reasons as to why we saw a peak in inflation in this current cycle, including of course supply/demand issues caused by the pandemic and the Russia-Ukraine conflict. All the same, the Fed and friends will be very keen to avoid a repeat of the 1970’s path. But does the timing of the first cut really matter? Is it not the size or magnitude of that first cut rather than its timing, or the number of cuts we see subsequently thereafter? Is it the reason for the decision to cut, rather than when that is more important? Is it not the timing of the last rate hike, rather than the timing of the first rate cut, which is important? All of these considerations could have an impact on the economic outlook and asset class returns. For now, volatility around inflation and economic data releases which could impact the path of interest rates is a possibility. As always, look through the short-term noise, and remain invested for the future. Are we there yet? Not quite. Visit lowesim.co.uk/insights and sign up to our weekly Ear to the Ground emails to receive insights, industry news and our thinking on current market trends straight to your inbox.

For those of you with children and/or grandchildren with whom you have endured a long journey with, this has to be the most dreaded question. Especially when it comes so early into the journey! With regard to the future direction of interest rates, however, it feels just as apt right now. We are now all very familiar with the meteoric rise which saw the UK base rate rise from 0.1% in December 2021 to 5.25% in August 2023. This was one of the steepest rate rising cycles we have seen in history as the Bank of England looked to defeat exceptionally high inflation, which was proving not as transitory as first envisaged. Sharp increases in interest rates were also seen in the US and Euro area for the very same reasons. With the annual rate of UK inflation, as measured by the consumer price index, having now fallen sharply from its peak of 11.1% in October 2022 to 3.2% in March this year, the rhetoric has now changed to when we will see the first interest rate cut. At 3.2%, inflation still remains above the target set for the UK central bank of 2%. Latest forecasts, however, suggest that this could be attained within the next few months. Key contributing factors include base effects, which is the comparing of prices now to 12 months ago. From April we saw a reduction in the energy price cap as set by Ofgem, which fell by £238 a year compared to the current price cap. So, with inflation moving nicely towards target, why have we not seen interest rate cuts in the UK already? At the last rate setting meeting in March, we perhaps received a hint that they were gearing up for the first one. At previous meetings two members of the committee had been advocating a rate hike. In March however, their opinion changed to one of ‘hold’ and we saw one member vote for a rate cut. We also saw Governor Andrew Bailey express optimism about the economic trajectory, suggesting that conditions were favourable for the central bank to begin cutting. As always there came a caveat, whereby he stressed the need for greater certainty regarding the control over price pressures. This is not just prevalent to the UK, but also to overseas economies. At the end of 2023 we saw the US Federal Reserve (the Fed) appear more amenable to interest rate cuts than previous. Markets were quick to price this aggressively, with some forecasters believing that we could see somewhere between six and seven cuts in 2024. Rolling forward to today and ‘sticky’ inflation, along with a slight pick up in the year on-year rate over the last couple of months, has seen the market roll back its forecasts, with two to three rate cuts now

Historical US Inflation Rate

Source: www.usinflationcalculator.com

9% 8% 7% 6% 5% 4% 3% 2% 1% 0

14% 12% 10%

8% 6% 4% 2% 0%

Dec 1969 to Dec 1983 (lhs) Sept 2017 to Mar 2024 (rhs)

1968

1970 1971 Jun Sep Dec Mar Jun Sep

1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Mar Dec

1982 1983 Sep Dec Mar Jun Sep

Mar

Dec

Dec

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