Bank Rate to be cut (sooner or later)

Emily Nicol
Chris Scicluna

Overview:
Wall Street ended yesterday little changed on the day after the FOMC unsurprisingly decided not to alter monetary policy fundamentally while also making technical adjustments to its interest rates on reserves and reverse repurchase agreements (see the comment from Daiwa America’s Mike Moran for more). But the mood in Asia today has been starkly different. With concerns about the economic impact of the coronavirus rising unabated, risk aversion has again dominated ahead of another meeting today of the WHO’s Emergency Committee, which will advise on whether the outbreak now constitutes a Public Health Emergency of International Concern (PHEIC).

So, as China’s offshore yuan fell through 7/$ for the first time this year, Hong Kong’s Hang Seng closed down more than 2½% for a second successive day. And Taiwan’s main market reopened from the Lunar New Year holiday by closing down a whopping 5¾%. Against that backdrop, the decline in the TOPIX of 1½% was somewhat more measured, but still left it on course for its worst week in eight months.

In the bond markets, meanwhile, USTs inevitably made further gains, with 10Y yields down another couple of bps to1.56%, a new three-month low. JGBs were stronger too (10Y yields down to -0.06%). And European government bonds have opened higher this morning too. That includes Gilts, for which 10Y yields are down about 4bps to 0.47%, also the lowest since early October, ahead of today’s BoE policy announcement. The MPC’s decision is a close call, with decent arguments for a cut but also a case for waiting until the near-term economic outlook is clearer. But if, as we suspect they might, the policymakers decide to sit on the side lines and leave policy unchanged today, we would still expect a 25bp cut in Bank Rate to come by May.

UK:
The main event in the UK today will obviously be the BoE’s policy announcement, the last under Carney’s stewardship and one that looks to be a very close call indeed. The prior two MPC meetings saw two external members – Haskel and Saunders – vote for a 25bp rate cut. And since the start of the year, three further members – Vlieghe, Tenreyro and Carney himself – suggested that they would be ready to vote for a rate cut if the economic recovery anticipated in the BoE’s November base case forecast was unlikely to materialise. So, certainly, there is a potential majority in favour of a rate cut today. And the economic case for a rate cut looks strong too.

In particular, several key economic data releases for Q4 – including retail sales and inflation – were weaker than expected, suggesting that there was probably more spare capacity at the end of 2019 than the BoE had previously thought. That would suggest that the BoE’s inflation forecast should be pulled lower across the projection horizon.

However, the improvement in the flash January PMIs suggests that the Bank’s updated forecasts will maintain a baseline of a rebound in economic activity from Q1 on. Whether that recovery will be considered sufficiently strong to push inflation back to target by the end of the BoE’s projection horizon, however, remains to be seen.

The Government’s forthcoming decision on fiscal policy (the Budget announcement is due on 11 March) will, however, have an important bearing on the outlook for growth and inflation. And so, some MPC members might wish first to have a clearer view of those plans before deciding whether to add stimulus. On the other hand, concerns surrounding the impact of the outbreak of China’s coronavirus on external demand would suggest that the risks to the outlook will remain significantly skewed to the downside, adding to the case for near-term policy easing.

On balance, we expect the majority of members to keep Bank Rate at 0.75% for a little longer yet, while also raising further the possibility of a near-term rate cut if and when the economic data fail to improve sufficiently over the near term. However, we would certainly not be surprised if the MPC voted for a 25bp rate cut today for risk management reasons. And we maintain our forecast that Bank Rate will be cut to 0.5% by May at the latest.

Data-wise, the latest Lloyds business barometer added to the more upbeat sentiment indicators seen since the turn of the year. Indeed, the headline optimism index jumped in January to a fourteen-month high to leave it 22pts above the recent trough reached in August. In contrast, however, today’s car production figures for the end of last year continued to disappoint.

In particular, car production fell a further 6.4%Y/Y in December, with a notable drop in production for domestic car buyers (-17.4%Y/Y) on the back of weakened consumer and business confidence at home. But production for overseas markets – which accounts for roughly 80% of total auto output – was also down more than 4%Y/Y, with the weakness in part reflecting a number of model production changes as well as the ongoing shift in demand away from diesel cars in Europe.

The December's figures concluded what can only be described as a dismal year for UK-based car manufacturers, with output down for the third consecutive year and by more than 14%Y/Y in 2019 to 1.3mn units, the lowest full-year reading since 2010. And not least due to ongoing uncertainty about the future trading arrangement with the EU, which since the Brexit referendum seen new investment in production facilities repeatedly channeled to other member states, SMMT anticipates another subdued year for UK car manufacturing, with output predicted to fall a further 2%Y/Y in 2020.

Euro area:
It will be a busy day for economic data from the euro area today. The first guide to inflation in January will come in the shape of Germany’s flash figures, which are expected to report an increase of 0.2ppt on the EU-harmonised measure to a nine-month high of 1.7%Y/Y. In addition, the euro area’s unemployment figures for December are expected to show the headline rate unchanged at 7.5% for a third successive month. And the European Commission’s economic sentiment survey for January – which provides the most comprehensive guide to euro area economic activity – is also due. With increased signs of stabilisation in the industrial sector, a third successive monthly increase in the headline economic sentiment index to a five-month high is expected.

Finally, ahead of Friday’s preliminary Q4 data from the euro area, France, Italy and Spain, today will bring the Belgian and Austrian growth estimates, which will follow this morning’s Lithuanian figures – the first to be released by any member state – that showed growth accelerated vigorously by 1ppt to 1.3%Q/Q, a four-quarter high. Of course, that is an admittedly volatile series which will also make minimal contribution to overall GDP growth.

US:
Today will bring the first estimate of US Q4 GDP, which is expected to report a third consecutive quarter of growth close to 2%Q/Q annualised. Consumer spending growth is expected to be moderate, but residential construction growth is likely to have been strong. While yesterday’s trade figures saw the deficit widen, it still suggested that net trade will have made a significant positive contribution, due principally to weak imports. Business investment, however, will likely have been weak again, while inventories probably made a large negative contribution to growth. The usual weekly jobless claims data are also due.

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