The central banking system of the United States has declared a reduction in interest rates, occurring mere hours prior to the anticipated decision from the Bank of England to maintain its current stance.
The Federal Reserve has lowered its primary funding rate by a quarter of a point, establishing a new target range of 4.25%-4.5%, aligning with market predictions, yet indicated that forthcoming cuts would likely proceed at a gradual pace.
A revival in inflation is a significant concern, especially with the potential reintroduction of trade tariffs under Donald Trump beginning 20 January, which could lead to an upsurge in the rate of US price hikes in the New Year, as the expenses for imported goods rise.
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Data released on Tuesday highlighted robust consumer spending, among other factors, prompting Fed policymakers to remain cautious regarding inflation trends ahead.
The Federal Open Markets Committee anticipates two reductions in rates by 2025. Just weeks prior, market forecasts had pointed to four cuts, consistent with the Fed’s guidance from September.
Chairman Jay Powell conveyed to journalists that solid economic expansion, enhanced employment figures, and advancements in tackling inflation placed the central bank in a “favorable position”.
However, he recognized that “policy uncertainty” surrounding the incoming Trump administration raises concerns regarding the inflation trajectory for several members of the committee.
Fed chair Jay Powell interacts with reporters File pic: Federal Reserve
“Our understanding of the actual policies remains quite limited, which makes it too early to draw any conclusions,” he remarked.
Government bond yields, indicative of expected future interest rate trends, experienced a slight increase.
The dollar gained traction, appreciating 0.5% against both the pound and euro, while leading US stock markets experienced a decline.
The Fed’s rate decision emerged just hours prior to the Bank of England unveiling its own rate decision.
No rate reduction is anticipated as financial markets expect a similar communication regarding prospective interest rate trajectories.
UK yields—the actual cost of managing government debt—have surged significantly this month, with the disparity between British and German 10-year bond yields reaching its highest point in 34 years earlier on Wednesday.
This reflects the contrasting interest rate outlooks for the Bank of England compared to the European Central Bank, which has consistently lowered rates to stimulate the euro area’s economy.
The dilemma for the UK is that both wage and price growth rates have escalated.
At the same time, economic growth appears to have stalled.
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Businesses respond to a contracting economy
This situation poses a distinctive challenge for the Bank.
Its governor, Andrew Bailey, has acknowledged that the impact of the budget on businesses raises significant uncertainty regarding future interest rate directions.
Concerns include the potential for companies to offset cost increases from tax raises and minimum wage hikes through price escalations.
Conversely, wage growth pressures may be alleviated if companies follow through on their warnings to limit pay increases due to budget constraints.
Currently, UK’s borrowing expenses appear poised to remain elevated for an extended duration, hindering economic advancement as intended, while simultaneously increasing the government’s obligations to service its debts.
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Chancellor comments on inflation increase
Although the Bank is largely anticipated to refrain from making a cut on Thursday, market predictions for a decrease in February, which seemed almost certain just a few weeks ago, now stand at merely 50% following the latest wage and inflation figures.
Currently, only two rate reductions are factored in for 2025.
The Bank’s commentary regarding the current price pressures will be under close examination.
Matthew Morgan, the head of fixed income at Jupiter Asset Management, provided insights about the US economic outlook, stating: “Presently, the market foresees just two additional cuts for the entirety of 2025. This is arguably unsurprising given the current state of consumer expenditure, the uncertainty in policy—particularly concerning tariffs—and a relatively healthy job market.”
“Nonetheless, we anticipate that expectations for US rate cuts will likely rise next year as economic growth moderates. The labor market is evidently cooling, inflation is declining, and both Europe and China pose challenges to global growth.”
“Given the unpopularity of high inflation during the Biden administration, we believe Trump will be cautious about excessively pursuing inflationary measures, such as tariffs. Coupled with potential cuts in US government spending, the forthcoming year may present favorable conditions for government bond performance.”
