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The US go big with a 50-basis point cut in interest rates, while the Bank of England does nothing at all.
US GDP is stronger than in the UK and the US year-over-year inflation rate is higher than that in the UK, yet the Bank of England chose not to act while the Fed went big.
Speaking last month in Jackson Hole, Jay Powell was explicit about what he considered the Federal Reserve’s mission as the US economy emerged from a gruelling inflation shock. “We will do everything we can to support a strong labour market as we make further progress towards price stability,” the chair said at the foothills of Wyoming’s Teton Range.
On Wednesday Federal Reserve acted and made its first interest rate cut since the early days of the Covid pandemic, slicing half a percentage point off benchmark rates in an effort to head off a slowdown in the labour market.
With both the jobs picture and inflation softening, the central bank’s Federal Open Market Committee chose to lower its key overnight borrowing rate by a half percentage point, or 50 basis points, affirming market expectations that had recently shifted from an outlook for a cut half that size.
Outside of the emergency rate reductions during Covid, the last time the FOMC cut by half a point was in 2008 during the global financial crisis.
The decision lowers the federal funds rate to a range between 4.75%-5%. While the rate sets short-term borrowing costs for banks, it spills over into multiple consumer products such as mortgages, auto loans and credit cards.
In addition to this reduction, the committee indicated through its “dot plot” the equivalent of 50 more basis points of cuts by the end of the year, close to current market pricing. The matrix of individual officials’ expectations pointed to another full percentage point in cuts by the end of 2025 and a half point in 2026. In all, the dot plot shows the benchmark rate coming down about 2 percentage points beyond Wednesday’s move.
“The Committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance,” the post-meeting statement said.
The decision to ease came “in light of progress on inflation and the balance of risks.” Notably, the FOMC vote was 11-1, with Governor Michelle Bowman preferring a quarter-point move. Bowman’s dissent was the first by a Fed governor since 2005, though a number of regional presidents have cast “no” votes during the period.
“We’re trying to achieve a situation where we restore price stability without the kind of painful increase in unemployment that has come sometimes with this inflation. That’s what we’re trying to do, and I think you could take today’s action as a sign of our strong commitment to achieve that goal,” Chair Jerome Powell said at a news conference following the decision.
Trading was volatile after the decision with the Dow Jones Industrial Average jumping as much as 375 points after it was released, before easing somewhat as investors digested the news and considered what it suggests about the state of the economy.
Stocks ended slightly lower on the day while Treasury yields bounced higher. This strange price movement had us puzzled but Chair Powell was insistent that nothing is set in stone.
“This is not the beginning of a series of 50 basis point cuts. The market was thinking to itself, if you go 50, another 50 has a high likelihood. But I think [Powell] really dashed that idea to some extent,” said Tom Porcelli, chief U.S. economist at PGIM Fixed Income. “It’s not that he thinks that’s not going to happen, it’s that he’s not he’s not pre-committing to that to happen. That is the right call.”
The committee noted that “job gains have slowed and the unemployment rate has moved up but remains low.” FOMC officials raised their expected unemployment rate this year to 4.4%, from the 4% projection at the last update in June, and lowered the inflation outlook to 2.3% from 2.6% previous. On core inflation, the committee took down its projection to 2.6%, a 0.2 percentage point reduction from June.
The committee expects the long-run neutral rate to be around 2.9%, a level that has drifted higher as the Fed has struggled to get inflation down to 2%.
The decision comes despite most economic indicators looking fairly solid.
Gross domestic product has been rising steadily, and the Atlanta Fed is tracking 3% growth in the third quarter based on continuing strength in consumer spending. Moreover, the Fed chose to cut even though most gauges indicate inflation well ahead of the central bank’s 2% target. The Fed’s preferred measure shows inflation running around 2.5%, well below its peak but still higher than policymakers would like.
Investors’ conviction on the move vacillated in the days leading up to the meeting. Over the past week, the odds had shifted to a half-point cut, with the probability for 50 basis points at 63% just before the decision coming down, according to the CME Group’s FedWatch gauge.
With the Fed at the centre of the global financial universe, Wednesday’s decision likely will reverberate among other central banks, several of whom already have started cutting. The factors that drove global inflation higher were related mainly to the pandemic – crippled international supply chains, outsized demand for goods over services, and an unprecedented influx of monetary and fiscal stimulus.
However, it failed to provoke The Bank of England into cutting on Thursday.
The Bank of England warned investors it won’t rush to ease monetary policy, deciding against a second consecutive cut in borrowing costs as it awaits further signs inflationary pressures have subsided.
The BOE’s Monetary Policy Committee voted 8-1 to keep rates steady at 5%, an outcome whose caution contrasts with the Fed’s half-point reduction. While the decision was in line with the expectations of economists and investors, it pushed the pound to its strongest level against the dollar since March 2022.
“We should be able to reduce rates gradually over time,” Governor Andrew Bailey said in a statement, stressing that such a path would depend on price pressures continuing to ease. “It’s vital that inflation stays low, so we need to be careful not to cut too fast or by too much.”
The BOE’s wary tone on the prospect of future loosening may dampen expectations in markets for the central bank to shift to quicker easing in borrowing costs later this year. Ahead of the meeting, investors had ramped up bets on successive moves from November, though policymakers didn’t explicitly endorse a change at their next gathering.
Money markets pared wagers on the extent of interest rate cuts this year, with 41 basis points of easing seen through December compared to 50 basis points before the decision. Gilts slipped, sending the 10-year benchmark yield three basis points higher to 3.88%, while the two-year yield was two basis points higher at 3.92%.
“The decision to keep base rates on hold aligns with our long-held view that the bank will take a cautious approach to the start of the cutting cycle,” said Dean Turner, chief European economist at UBS Global Wealth Management. “Taken together with an economy showing few signs of stress, policymakers have time on their hands.” He expects a second rate cut in November.
Officials in London didn’t know the result of the meeting in Washington when they reached their own judgment. They might have stepped up if they had, but we’ll never know. The Bank of England is always over cautious and too focussed on inflation rather than growth which could hurt the economy.
The vote shows that recent data featuring slower-than-expected disinflation and the UK economy’s recovery fizzling out has yet to convince officials that the threat from consumer prices has been sufficiently contained. Swati Dhingra, the committee’s most dovish member, was the sole voice backing an immediate quarter-point reduction.
The BOE reduced rates for the first time in over four years last month in a tight 5-4 vote, with Chief Economist Huw Pill in the hawkish ranks opposing a move. However, the policy guidance in Thursday’s minutes added language that warned investors that officials will take their time in reversing the most aggressive tightening in decades.
“In the absence of material developments, a gradual approach to removing policy restraint remains appropriate,” the minutes said. The guidance reiterated their preference for a meeting-by-meeting approach and the need for policy to remain “restrictive for sufficiently long.”
The vow for a patient stance comes despite recent data suggesting that the threat from consumer prices is fading. Data on Wednesday showed inflation held at 2.2% in August, staying below the BOE’s forecast for 2.4%. Wage growth has continued to gradually ease and the economy has cooled, with gross domestic product stagnating in three out of the last four months.
The BOE said that it now expects output growth to slow to 0.3% in the third quarter, slightly weaker than the 0.4% predicted in its August forecasts. Inflation is anticipated to pick up to 2.5% by the end of the year, slightly lower than the 2.8% previously projected.
The impact on our platform:
Global stocks have moved a fair amount since 7pm yesterday Evening (FED announcement), and in the main to the upside. At TPP, our trackers have continued to track so they've profited, some of our long or flats used the opportunity to move flat by taking profit on the BUY side, and some of our active strategies now have a net SELL position after taking profit on the BUY side trades.
The next few trading days might provide a better guide as to where markets will go from here, and hopefully will set ALL of our strategies on the right path to end the month on a high.
Interesting times.
Enjoy the rest of your week.
