Expect the first fall in interest rates in the UK to come in May. Why so sure? Well, let’s start with what is happening here.
This coming Thursday we get the quarterly update on the economy from the Bank of England in its Monetary Policy Report.
It was originally called the Inflation Report, but the Bank thought it had got inflation under control, so in November 2019 it renamed it – whereupon inflation duly returned with a vengeance.
The new forecast will upgrade the Bank’s growth outlook for this year from zero – which always looked overly pessimistic – to about 0.5 per cent, and it will downgrade expectations for inflation from 3.1 per cent to about 2.5 per cent.
Rate cuts: Our inflation rate is slightly higher than that of the US and Eurozone, so we have to wait until they move. Once they do, we can follow, says Hamish McRae
These revisions will bring the Bank more or less in line with the consensus, but the decline in inflation won’t be nearly enough to clear the way for a cut in rates.
Actually, I think the headline rate for the Consumer Price Index, now 4 per cent, may have gone up a little in January. We get that number in the middle of next month.
The big fall in the CPI, maybe even below 2 per cent, is likely to come in April. That will be the trigger for the rate-setting Monetary Policy Committee (MPC) to start cutting in May.
There is an external reason for expecting this timing. Other central banks will have moved.
The markets reckon on a 50-50 chance of the US Federal Reserve starting cutting in March, and expect the European Central Bank to do so in April.
That gives us cover. Our inflation rate is slightly higher than that of the US and Eurozone, so we have to wait until they move. Once they do, we can follow.
But what about growth?
Here the story gets really interesting. The economy was pretty flat during the second half of last year. It is possible with the strikes that there may even have been a recession, though experience has taught us that statisticians usually find their early estimates have to be revised up, and I expect this will happen again.
But looking ahead, the outlook is much more positive, indeed almost startlingly so.
The best forward-looking indicators are the so-called purchasing managers’ indices, PMIs. If you are not familiar with them, that is a clumsy name for a clever idea. If you are up to speed on this, skip the next two paragraphs.
Looking ahead, the outlook is much more positive, indeed almost startlingly so
You ask people who do procurement for companies a simple question about a number of variables – orders, deliveries, employment, prices, and so on. The question is whether they expect things to get better, worse, or stay the same.
You then look at all the answers, weight the companies by size, type of business and so forth, and see whether on balance they expect growth or contraction on a scale of one to 100.
So 50 would mean no change, anything below means a decline and anything above signals expansion. The latest number for the UK’s composite PMI, which covers the whole economy, is 52.5, so that is saying business expects reasonable, though not particularly rapid growth.
But it is ahead of the US at 52.3 and Japan at 51.1.
For Europe there is a much gloomier picture. For the Eurozone as a whole it is 47.9, for Germany 47.1, and for France a really glum 44.2.
On the up: The UK Services PMI Input Prices Index
I find those numbers stunning. British businesspeople are more optimistic than their peers in the US and Japan, and vastly more so than those on the Continent, especially Germany and France.
Yet they were grossly under-reported, and as far as I can see have not really filtered through into market sentiment.
I can’t quite believe the UK economy will indeed outpace the US this year but, unless there is a dramatic shift in those PMIs, it will surely outpace Germany, France and the Eurozone as a whole.
> PMIs: UK services sector grows at fastest pace for six months
So what’s to look for next?
First, I expect progressive upgrades for UK growth this year. Simon French, economist at Panmure Gordon, forecasts 1.2 per cent, which is way above the consensus, but would be consistent with those PMIs. If confidence continues to build, growth could top that.
Expect this improved outlook to feed through into the markets
Second, expect this improved outlook to feed through into the markets as people cotton on to the implications.
The UK market is undervalued, and if there is money to be made by buying British firms on the cheap, that will happen. One of a professional investor’s skills is to anticipate changes in perception – to get ahead of the herd.
Finally, expect the pound also to benefit. That is undervalued too.
It is impossible to time that recovery, but it might, just might, come in time for the summer holidays. It would be nice if it did.
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