When, and by how much, are rates likely to be cut in 2024? After the central banks of the US, UK and EU hiked interest rates to their highest levels in years, the question has become increasingly pressing. Recent economic news has highlighted a divergence in economic performance between the US and UK, and caused investors to alter their expectations over the size and timing of rate cuts.
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The one-year overnight index swap rates for the US dollar, euro and sterling declined throughout most of Q4 last year on the back of falling inflation. This decline indicates that investors became increasingly confident that the central banks would cut rates significantly in the coming year. With oil and gas prices falling and inflation set to fall further, the case for trimming rates appears strong.
The argument for US rate cuts has however been tempered somewhat by recent economic data: the US jobs report showed that 353,000 new nonfarm payrolls were added in January, well ahead of expectations, and headline inflation in the same month came in at 3.1%, also higher than expected. Over the past month, investors have priced out around 75bps of expected easing this year.
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By contrast, the case for rate cuts in the UK appears stronger, even though inflation remains further above target than in the US. The inflation figure for January came in lower than expected last week, at 4.0%, while the Q4 GDP print showed that the economy contracted by 0.3% quarter-on-quarter. By some definitions, this means that the UK went into a technical recession in the second half of last year; more concerningly, it also means that real per capita GDP has now contracted in seven consecutive quarters. This weakness ought to increase the odds of rate cuts, although the Bank of England Governor, Andrew Bailey, has on several occasions expressed concern about wage growth, which, is now exceeding headline inflation, as it is in the US.
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We believe that the UK economy is either in recession or is about to enter recession, led by weaker consumer spending. In drawing that conclusion, we put little weight on the fact that the economy has contracted, moderately, for two consecutive quarters. Rather we focus on the behaviour of UK households who, despite sitting on a substantial pile of savings built up during the pandemic, are now, and in contrast to their US counterparts, saving an even greater proportion of their disposable income. This suggests a greater degree of pessimism in the economic outlook, and risks making recession self-fulfilling – Keynes’s paradox of thrift. Although private sector wage growth remains some way above rates consistent with the 2% inflation target, we expect wage inflation and consumer price inflation to fall sharply as the economy slows. The Bank of England is likely to cut more aggressively this year than is currently priced in, as is almost always the case during a cutting cycle.
The views expressed in this article are the views of the author, not necessarily those of LSEG.
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