According to the latest money market pricing, the first interest rate cut by the Bank of England (BoE) is fully priced in by August. This is much earlier than for the US. Following yesterday’s release of the US inflation report, financial markets have now dialled back their expectations for the first rate cut to September from June, according to CME’s FedWatch Tool. But “markets are moving rate cut bets in the wrong direction,” Megan Greene cautioned in her article in the Financial Times. Greene is one of the more hawkish members of the MPC and believes “that rate cuts in the UK should still be a way off as well,” and not come earlier than the US.
The pound weakened after markets brought forward the expected first cut to June from August following last month’s Bank of England interest rate decision.
Greene’s remarks are in contrast with those made by BoE Governor Andrew Bailey, who has described the prospect of rate cuts this year as “not unreasonable.”
Jonathan Haskel, one of the Monetary Policy Committee’s (MPC) most hawkish members, has also said that rate cuts should be “a long way off.” Catherine Mann, another MPC member, also agrees that cutting rates in June is too soon.
The next policy decision by the MPC is due on 9 May.
Inflation remains high
The persistence of inflationary pressures means that rate cuts should not come any time soon. In her article titled “Markets must stop comparing the UK and the U.S.”, Greene said that the risk of inflation in the UK was far greater than in the US.
“Following surprisingly strong U.S. March CPI inflation, markets now expect the Bank of England will cut rates earlier and by more than the Federal Reserve this year,” Greene said.
Green is worried about wages which are rising faster in the UK than in the US – and which have generated a higher risk of stubborn inflation.
“Higher inflation expectations have translated into higher pay growth, by some metrics now between 6-7 per cent in the UK versus 4-5.5 per cent in the US. Such sticky wage growth is a significant component of services inflation. It will need to slow further to see services inflation return sustainably to target-consistent levels. This last mile may prove the hardest. UK services inflation remains much higher than in the US.”
Greene highlighted the difference in labour supply between the two countries with British services inflation remaining much higher than in the US.
“Overall labour market participation in the UK has not recovered to the pre-pandemic trend. Participation in the U.S., on the other hand, has exceeded the pre-COVID trend.”
British annual consumer price inflation dropped in February to 3.4% and is expected to drop below the BoE’s 2% target in the April-June period before increasing slightly again.
How many rate cuts in the UK?
According to LSEG data, money markets expect around 45 basis points of interest rate cuts by the BoE this year and the first-rate cut is fully priced in for August. This exceeds the 42 bps of rate cuts by the Fed priced in by investors. Following the hot US inflation figures, markets have also pushed back their expectations for a Bank of England rate cut in June, but this remains a potential scenario. As Greene noted, “Momentum in the markets has been towards pricing in later rate cuts by the Fed as economic growth remains robust. In my view, rate cuts in the UK should still be a way off as well.”