The first interest rate fall in the UK is expected in May. Why are we so sure? Well, let’s start with what’s going on here.
This Thursday, the Bank of England will issue its quarterly update on the economy in its Monetary Policy Report.
The report was originally called the Inflation Report, but the central bank changed its name in November 2019 because it believed inflation had been brought under control. Then inflation came back with a full vengeance.
The new outlook raises the central bank’s growth outlook for this year from zero (always seen as too pessimistic) to about 0.5%, and lowers its inflation expectations from 3.1% to about 2.5%.
These revisions bring the Bank more or less in line with the consensus, but the decline in inflation is not enough to pave the way for rate cuts.
As a matter of fact, the headline rate for the consumer price index is currently 4%, but I think it may have increased a little bit in January. You will receive the number in the middle of next month.
A significant drop in CPI, possibly below 2%, is likely to occur in April. This will trigger the Monetary Policy Committee (MPC), which sets interest rates, to start cutting interest rates in May.
There are external reasons to expect this timing. Other central banks will also move.
Markets see a 50-50 chance that the U.S. Federal Reserve will start cutting interest rates in March, and expect the European Central Bank to start cutting rates in April as well.
That gives us cover. Our inflation rate is slightly higher than that of the US or the Eurozone, so we have to wait until they move. Once they do, we can follow suit.
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How can this be money help?
But what about growth?
This is where the story gets really interesting. The economy was almost flat in the second half of last year. In the case of strikes, there may even have been a recession, but experience has taught us that statisticians usually have to revise their initial estimates upwards, and I expect this to happen again.
But when we look to the future, the outlook is much more positive, in fact, surprisingly so.
The best forward-looking indicator is the so-called Purchasing Managers’ Index, PMI. For those not familiar with these, I think it’s a clumsy name for a clever idea. If you understand this, please skip the next two paragraphs.
Looking to the future, the outlook is much more positive, almost surprising, in fact.
Ask the people responsible for corporate procurement simple questions about a variety of variables such as orders, deliveries, hiring, and pricing. The question is: do they expect things to get better, worse, or stay as they are?
We then look at all the responses, weight the companies by size, type of business, etc., and see on a scale of 1 to 100 whether they expect overall growth or contraction.
Therefore, 50 means no change, below it means a decline, and above 50 means an expansion. The latest reading for the UK’s economy-wide composite PMI is 52.5, indicating that businesses are expecting reasonable, if not particularly rapid, growth.
However, it is 52.3 times higher than the United States and 51.1 times higher than Japan.
There is a much bleaker picture for Europe. The eurozone as a whole is at 47.9, Germany is at 47.1, and France is at 44.2.
I think this number is surprising. British businessmen are more optimistic than businessmen in the United States or Japan, and much more optimistic than businessmen on the continent, especially Germany or France.
However, they are significantly underreported and, to my knowledge, do not reflect well in market sentiment.
I have no idea that the UK economy will actually outperform the US this year, but unless there is a dramatic change in the PMIs, it will definitely outperform Germany, France and the entire euro area.
> PMI: UK services sector grows at fastest pace in past six months
So what should you look for next?
Firstly, I expect UK growth to improve incrementally this year. Panmure Gordon economist Simon French expects 1.2%, well above consensus but in line with these PMIs. If confidence continues to rise, growth could outpace that.
We hope this improved outlook will be reflected in the market.
Second, we hope that this improved outlook will be reflected in the market as people understand the implications.
The UK market is undervalued and if there is money to be made by buying British companies cheaply then so be it. One of the skills of a professional investor is to anticipate changes in perception and stay ahead of the crowd.
Finally, we expect the pound to benefit as well. It’s also underrated.
It is impossible to time the recovery, but it may be possible in time for summer vacation. I hope that happens.
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