CPI inflation rates are at their lowest since 2016 - Cut is assured

Cable was offered and gilt yields fell after some pretty lacklustre UK inflation data. In summary, inflation was a fair bit weaker than expected in December and this will offer the necessary cover for the Bank of England to cut interest rates this month. I feel this may persuade a couple more on the MPC to cut now, to get ahead of the curve and not allow softer data to fester. 

GBPUSD slipped 1.30 but bears are finding support around this region tough to crack. 2yr gilts were bid with yields down a tenth again to 0.441%. The FTSE went in the other direction to firm up 17pts. 

Inflation rose just 1.3% against 1.5% in November. Core CPI was a meagre +1.4% last month, vs 1.7% expected. CPI inflation rates are at their lowest since 2016. Prices for hotel rooms and women’s clothing dropped – good news for some.

This gives the Bank of England all the excuse it needs to cut later this month. Coming off the back of those weaker GDP and industrial production numbers, it does not look as though the economy was firing on all cylinders at the tail end of last year. While there may well be a Boris Bounce in the offing, I rather think the die is cast in favour of a rate cut.  

As explained on Monday: There is a sense the Bank doesn’t want to get behind the curve of market expectations, and is seeking to get a jump on markets whilst still teeing up the cut. It would be following the Fed’s playbook in cutting early in order to prevent a downturn. This is the key thing to remember – the Bank does not want to let a weaker economy fester. And whilst there is no trade deal with the EU, the MPC has been largely released from the shackles of Brexit uncertainty following the Conservative victory last month. Political risk has hobbled the MPC but this has diminished greatly and now is the window – before a possible clash with the EU in the spring that would make policy changes more political in nature – to get a cut in the bag to juice the economy.  Moreover, one can imagine that the Bank had sight of these numbers and wanted to get the first punch in with some dovish comments from policy makers. 

Meanwhile, MPC rate setter – and known dove – Michael Saunders has been on the airwaves talking up downside risks to the economic outlook which will necessitate early policy action. Now Saunders is a dove and voted for a cut at the last two MPC meetings but it nonetheless adds to the sense that the Bank is erring towards a cut this month, coming as it does shortly after those dovish comments by Gertjan Vlieghe, as well as jawboning by Carney and Tenreyro that was rather dovish.

Failure to cut now would amount to some significant de facto tightening that the Bank would not wish to see at this juncture. Cut is assured. 

Saunders comments summary 

• Rate cut not now would not be precautionary, economy has capacity to grow faster 

• Risk management supports rate cut, but case stands without it, QE limited by low gilt yields 

• Risk management favours prompt and aggressive policy response 

• Growth could improve and still be sluggish, evidence of post-election bounce is limited 

• Appropriate to remain expansionary and cut rates further