Friday Forward Guidance ...
This is our Friday Forward Guidance for Friday 22nd September. Every week we update our scenario forecasts for base rates in the U.S., UK and Europe over a three year period. We also include our expectations for inflation, as an input to the central bank reaction function, in the Saturday Economist updates.
In latest central bank moves, the ECB raised rates by 25 basis points The Federal Reserve and the Bank of England left base rates unchanged in the September meetings.
Where Are Rates Headed? Bet on Higher for Longer but probable not by much. A further 25 point rise is possible in the U.S. and the U.K. The ECB is indicating the high point in the cycle may well have been reached.
"Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target."
The Fed is more agnostic. “It is certainly possible that we would raise funds again at the September meeting if the data warranted,” Fed Chairman Jerome Powell told reporters last month. “And I would also say it’s possible that we would choose to hold steady at that meeting.” Now the Fed has introduced the concept of an "aggressive pause". Rates on hold for now but watch this space.
Andrew Bailey, Governor of the Bank of England was equally enigmatic. "I am not going to judge what the path of rates will be, not least because more than one path may deliver inflation back to target. We will judge what is the most appropriate based on the evidence".
In latest central bank moves, the ECB raised rates by 25 basis points The Federal Reserve and the Bank of England left base rates unchanged in the September meetings.
Where Are Rates Headed? Bet on Higher for Longer but probable not by much. A further 25 point rise is possible in the U.S. and the U.K. The ECB is indicating the high point in the cycle may well have been reached.
"Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target."
The Fed is more agnostic. “It is certainly possible that we would raise funds again at the September meeting if the data warranted,” Fed Chairman Jerome Powell told reporters last month. “And I would also say it’s possible that we would choose to hold steady at that meeting.” Now the Fed has introduced the concept of an "aggressive pause". Rates on hold for now but watch this space.
Andrew Bailey, Governor of the Bank of England was equally enigmatic. "I am not going to judge what the path of rates will be, not least because more than one path may deliver inflation back to target. We will judge what is the most appropriate based on the evidence".
Fed Funds Rate ...
In the latest move the Fed left rates on hold. The target range for the Fed funds rate was held at 5.25% to 5.50%.
The median projection for the appropriate level of the federal funds rate is now considered to be 5.5 percent in 2023 easing to 5% in 2024. Markets assume the Fed rate hike cycle may be "close to being over". The Fed blue dot forecasts suggested there could be one further rate rise this year with no cuts in prospect until late 2024.
Inflation CPI eased up, to 3.7% in August from 3.2% in July. Producer price inflation eased up to 1.6% from 0.8% in July.
Growth in the U.S. accelerated to 2.5% in the second quarter from 1.8% in Q1. The US economy is in better shape than economists had expected. A strong labor market, sturdy consumer spending and now easing inflation have fueled hopes that the US will avoid a downturn. The Fed staff is no longer forecasting a recession this year.
The Fed forecasts growth of 2.1% in 2023 easing to 1.5% in 2024.
We model U.S. base rates peaking at 5.50% in 2023 (one hike left) moving to 4.50% in late 2024. The Fed Blue Dot forecasts suggest the Long Run average rate in the U.S is now 2.50%. Our model rate is around the 4.00% -4.50% level.
This is our "We are leaving Planet ZIRP" scenario. Grab a ticket for the flight, don't buy a return, this is a one way trip.
In the latest move the Fed left rates on hold. The target range for the Fed funds rate was held at 5.25% to 5.50%.
The median projection for the appropriate level of the federal funds rate is now considered to be 5.5 percent in 2023 easing to 5% in 2024. Markets assume the Fed rate hike cycle may be "close to being over". The Fed blue dot forecasts suggested there could be one further rate rise this year with no cuts in prospect until late 2024.
Inflation CPI eased up, to 3.7% in August from 3.2% in July. Producer price inflation eased up to 1.6% from 0.8% in July.
Growth in the U.S. accelerated to 2.5% in the second quarter from 1.8% in Q1. The US economy is in better shape than economists had expected. A strong labor market, sturdy consumer spending and now easing inflation have fueled hopes that the US will avoid a downturn. The Fed staff is no longer forecasting a recession this year.
The Fed forecasts growth of 2.1% in 2023 easing to 1.5% in 2024.
We model U.S. base rates peaking at 5.50% in 2023 (one hike left) moving to 4.50% in late 2024. The Fed Blue Dot forecasts suggest the Long Run average rate in the U.S is now 2.50%. Our model rate is around the 4.00% -4.50% level.
This is our "We are leaving Planet ZIRP" scenario. Grab a ticket for the flight, don't buy a return, this is a one way trip.
Bank Base Rate...
Inflation, CPI eased to 6.7% in August from 6.8% in July. Core inflation, eased to 6.2% from 6.9%. Inflation peaked in October but inflation remains "sticky". Food inflation has eased to 13.4%. Energy costs collapsed to 4.5% from 23.3% last month but eased up to 5.3% in August as oil prices increased. Service sector inflation eased to 6.8% from 7.4%. Goods inflation moved up to 6.3% from 6.1% .
Producer Prices are moving in the right direction. Input prices were at -2.0% in August. Output prices moved to -0.4 % from -0.7% prior month. We expect input and output prices to be negative in Q3 and Q4. Headline consumer price inflation will drop below 5% in the final quarter of the year.
Markets and the MPC have been spooked by the latest data on earnings. Earnings increased by 8.5% in July. The government says it accepts in full recommended public pay rises of 5 - 7% for police, teachers and doctors. The latest guarantees on public sector pay will continue to alarm the hawks. Public sector pay increased by 10.5% in July.
The latest GDP data suggests the economy expanded by 0.5% in the first quarter and by 0.4% in the second quarter. In the first half of the year, growth was 0.4%. Unexciting maybe, but still suggests much of the gloom and doom is overdone. The latest GDP ONS "Nowcast" suggest zero growth in July. We are wary of a one month data point.
At its meeting ending on 20 September 2023, the MPC voted by a majority of 5–4 to maintain Bank Rate at 5.25%. Four members preferred to increase Bank Rate by 0.25 percentage points, to 5.5%.
Annual CPI inflation is expected to fall below 5% in the final quarter. CPI inflation is expected to return to the 2% target by 2025 Q2.
Looking further ahead, the MPC stated it will ensure that Bank Rate is sufficiently restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term., in line with its remit.
We maintain our base rate peak this year at 5.5% on the basis of a further 25 basis point hike in November. We attache a 60% probability of this event. We model 4.50% as the long run rate for base rates and ten year gilts in life after Planet ZIRP. Note that 10 year gilt yields eased to 4.3% on the latest bank news.
NIESR are now forecasting growth of 0.4% this year. The IMF, now not so gloomy, expect the U.K. to avoid recession this year with growth of around 0.4%. The latest OECD forecast opts for growth of 0.3% this year and 1.0% next.
* Long Term Note : In the UK, prior to the Great Financial Crash [2000 - 2008] the average inflation rate was 2.0%, the average UK bank rate was 4.50%. Ten year bond yields averaged 4.50%, real GDP growth averaged 2.5% and the unemployment rate averaged 5%.
Inflation, CPI eased to 6.7% in August from 6.8% in July. Core inflation, eased to 6.2% from 6.9%. Inflation peaked in October but inflation remains "sticky". Food inflation has eased to 13.4%. Energy costs collapsed to 4.5% from 23.3% last month but eased up to 5.3% in August as oil prices increased. Service sector inflation eased to 6.8% from 7.4%. Goods inflation moved up to 6.3% from 6.1% .
Producer Prices are moving in the right direction. Input prices were at -2.0% in August. Output prices moved to -0.4 % from -0.7% prior month. We expect input and output prices to be negative in Q3 and Q4. Headline consumer price inflation will drop below 5% in the final quarter of the year.
Markets and the MPC have been spooked by the latest data on earnings. Earnings increased by 8.5% in July. The government says it accepts in full recommended public pay rises of 5 - 7% for police, teachers and doctors. The latest guarantees on public sector pay will continue to alarm the hawks. Public sector pay increased by 10.5% in July.
The latest GDP data suggests the economy expanded by 0.5% in the first quarter and by 0.4% in the second quarter. In the first half of the year, growth was 0.4%. Unexciting maybe, but still suggests much of the gloom and doom is overdone. The latest GDP ONS "Nowcast" suggest zero growth in July. We are wary of a one month data point.
At its meeting ending on 20 September 2023, the MPC voted by a majority of 5–4 to maintain Bank Rate at 5.25%. Four members preferred to increase Bank Rate by 0.25 percentage points, to 5.5%.
Annual CPI inflation is expected to fall below 5% in the final quarter. CPI inflation is expected to return to the 2% target by 2025 Q2.
Looking further ahead, the MPC stated it will ensure that Bank Rate is sufficiently restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term., in line with its remit.
We maintain our base rate peak this year at 5.5% on the basis of a further 25 basis point hike in November. We attache a 60% probability of this event. We model 4.50% as the long run rate for base rates and ten year gilts in life after Planet ZIRP. Note that 10 year gilt yields eased to 4.3% on the latest bank news.
NIESR are now forecasting growth of 0.4% this year. The IMF, now not so gloomy, expect the U.K. to avoid recession this year with growth of around 0.4%. The latest OECD forecast opts for growth of 0.3% this year and 1.0% next.
* Long Term Note : In the UK, prior to the Great Financial Crash [2000 - 2008] the average inflation rate was 2.0%, the average UK bank rate was 4.50%. Ten year bond yields averaged 4.50%, real GDP growth averaged 2.5% and the unemployment rate averaged 5%.
Euro Base Rate...
EU annual inflation eased to 5.9% in August, down from 6.1% in July, according to latest data from Eurostat, the statistical office of the European Union.
Official figures showed that inflation in the Eurozone eased to 5.2 per cent in August and July, from 5.3 per cent in July. Inflation is expected to average 5.6% in 2023, before dropping to 2.9% in 2024 and 2.2% in 2025 according to projections from ECB staff.
At the September meeting, the Council stated "Inflation continues to decline but is still expected to remain too high for too long. The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner.
In order to reinforce progress towards its target, the Governing Council today decided to raise the three key ECB interest rates by 25 basis points. Accordingly, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be increased to 4.50%, 4.75% and 4.00% respectively, with effect from 20 September 2023.
The September ECB staff macroeconomic projections for the euro area see average inflation at 5.6% in 2023, 3.2% in 2024 and 2.1% in 2025. This is an upward revision for 2023 and 2024 and a downward revision for 2025. The upward revision for 2023 and 2024 mainly reflects a higher path for energy prices.
ECB staff have lowered their economic growth projections significantly. They now expect the euro area economy to expand by 0.7% in 2023, 1.0% in 2024 and 1.5% in 2025.
Based on its current assessment, the Governing Council considers the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.
We have said " We expect rates (main refinancing operations) to peak at 4.50% in the third quarter. Deposit rates will increase to 4.00%.
EU annual inflation eased to 5.9% in August, down from 6.1% in July, according to latest data from Eurostat, the statistical office of the European Union.
Official figures showed that inflation in the Eurozone eased to 5.2 per cent in August and July, from 5.3 per cent in July. Inflation is expected to average 5.6% in 2023, before dropping to 2.9% in 2024 and 2.2% in 2025 according to projections from ECB staff.
At the September meeting, the Council stated "Inflation continues to decline but is still expected to remain too high for too long. The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner.
In order to reinforce progress towards its target, the Governing Council today decided to raise the three key ECB interest rates by 25 basis points. Accordingly, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be increased to 4.50%, 4.75% and 4.00% respectively, with effect from 20 September 2023.
The September ECB staff macroeconomic projections for the euro area see average inflation at 5.6% in 2023, 3.2% in 2024 and 2.1% in 2025. This is an upward revision for 2023 and 2024 and a downward revision for 2025. The upward revision for 2023 and 2024 mainly reflects a higher path for energy prices.
ECB staff have lowered their economic growth projections significantly. They now expect the euro area economy to expand by 0.7% in 2023, 1.0% in 2024 and 1.5% in 2025.
Based on its current assessment, the Governing Council considers the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.
We have said " We expect rates (main refinancing operations) to peak at 4.50% in the third quarter. Deposit rates will increase to 4.00%.
Scenario Comparisons ...
This is the table of scenario comparisons. We would expect UK rates to lag not lead the US pattern. EU rates would follow the US/UK lead. Inflation may subside sooner than expected. Central banks may worry about the shock to growth. This is a scenario not the plan.
Our modified Taylor rule suggests the UK central bank is behind the curve on rate hikes. In our modified Taylor rule we model base rates as a function of inflation variance from target and the output gap relative to trend growth.
We model the long run rate at 4.0%. The Fed Blue dot projections assume 3.50% as the perceived long run rate. In the UK, prior to the Great Financial Crash [2000 - 2008] the average inflation rate was 2.0%, the average UK bank rate was 4.50%. Ten year bond yields averaged 4.50%. Some way to go yet, in the return to normality!
This is the table of scenario comparisons. We would expect UK rates to lag not lead the US pattern. EU rates would follow the US/UK lead. Inflation may subside sooner than expected. Central banks may worry about the shock to growth. This is a scenario not the plan.
Our modified Taylor rule suggests the UK central bank is behind the curve on rate hikes. In our modified Taylor rule we model base rates as a function of inflation variance from target and the output gap relative to trend growth.
We model the long run rate at 4.0%. The Fed Blue dot projections assume 3.50% as the perceived long run rate. In the UK, prior to the Great Financial Crash [2000 - 2008] the average inflation rate was 2.0%, the average UK bank rate was 4.50%. Ten year bond yields averaged 4.50%. Some way to go yet, in the return to normality!
That's all for this week ... "to understand the markets you have to understand the economics" and we do ...
© 2023 John Ashcroft, Economics, Strategy and Financial Markets, experience worth sharing.
© 2023 John Ashcroft, Economics, Strategy and Financial Markets, experience worth sharing.