Have interest rates peaked?

Dr Yueh discusses starkly different conditions in the US and UK that may determine the direction of interest rates

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The Bank of England governor Andrew Bailey has continuously warned that the BoE will not cut UK interest rates any time soon, even with a recent sharp fall in consumer price inflation.

“Recent decisions by both the ECB and Norges Bank of Norway are all adding to the theory that interest rates might hold at higher levels,” said Dr Yueh.

Meantime, in the US, growth in the economy continues to improve while inflation declines. Fed Board Governor Dr Christopher Waller has indicated that interest rate cuts could come down sooner than initially expected.

Waller said there was "no reason" that rates must stay "really high" if inflation keeps declining consistently.

Along those lines, Dr Yueh emphasized the Fed’s dual mandate of maintaining price stability and sustainable employment.

“In US, the jobs data was slightly weaker than forecasts had expected, with 150,000 new jobs added to the labor market last month. A Bloomberg survey thought that it would be of the order of around 180,000 jobs in October,” said Yueh.

“Unemployment rose to 3.9 per cent in October, a gain of point one per cent from September’s figures. Average earnings did edge up a little bit higher by 0.2 per cent, but that is also a slowdown from the previous month. It is interesting to note that the policy interest rate is beginning to affect the labor market, which apart from taming inflation is a core mandate for the Fed. US core PCE is hovering around 3.5 per cent, giving a sense that the dampening effect of rates is beginning to be felt.”

Commenting on the Fed chief Jay Powell’s observation that he is proceeding carefully with future rate rises, Dr Yueh said that a further slowing of the US economy will force the Fed to examine with care the second part of their dual mandate.

“It is worth reflecting that only half of the rate rises we have seen in the past year across the major economies have gone through the economy. It takes about two years for the full effect to come through, so inevitably there will be a continued impact from this long series of raised interest rates. The question is that if rates have currently peaked in the US, how long will they need to be held given that inflation is still running at 3.7 per cent still, above the Fed’s target of two per cent. This present summit of interest rates that have been reached begs the question, ‘how big is this mountain top?’, and how long will the Fed use these restrictive interest rates to dampen inflation?”

Turning to the UK economy and the continued battle against inflation by the BoE, Dr Yueh observed that the US economy is in a much better position than that of the United Kingdom.

“In the UK, there has also been a pause in interest rates. A recent decision taken by the Monetary Policy Committee (MPC) voted 6 to 3 not to raise interest rates.  It was a split vote signifying the tensions between taming inflation and wider concerns about the impacts of higher interest rates on the wider economy.”

Looking at what financial markets think, Dr Yueh said that the markets are acknowledging that the economy is becoming weaker, “so they’re pricing in a rate cut sooner than the BoE has indicated”.

With the rate of unemployment increasing to 4.20 per cent, and a growing number of business failures – levels not seen since the global financial crisis - the BoE is placed in a very tough position. “If inflation remains above target and the economy is weakening, markets will expect a rate cut in the second half of next year,” said Yueh.

With the expectation is that the UK economy will flatline for all of ’24, the situation is much more febrile than that of the US. “If the UK economy is growing at zero per cent, it doesn’t take much to tip it into recession and therefore the big challenge for the BoE is whether to hold rates as they are in the middle of recession.”

Data, or the absence of good data, is one of the biggest challenges facing the BoE.

“The UK has struggled with accurate data since the pandemic and launched a new survey to deal with it poor labour market statistics. These are the crucial factors for the BoE.”

To listen to a clip from the Sirius XM podcast with Dr Yueh, click here