BOE Decision Day

• The Bank of England interest rate decision is today’s main event. We expect a rate cut.

• The Fed stood pat yesterday but signalled a September rate cut is in the pipeline.

• China private sector manufacturing activity unexpectedly contracts in July.

USD is recovering slightly while US equity futures and yields on Treasury futures are up. Yesterday, dovish comments by Fed Chair Jay Powell during his post-FOMC meeting press conference weighed on USD and dragged Treasury yields lower. Powell pointed out “a reduction in our policy rate could be on the table as soon as the next meeting in September” but added “there was a real discussion back and forth of what the case would be for moving at this meeting”.

Otherwise, the outcome of the FOMC meeting largely matched consensus. The target range for the Fed funds rate was kept at 5.25-5.50% (widely expected) and the FOMC reiterated it “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.”

However, the FOMC is increasingly concerned about the US labor market. The FOMC statement emphasized it “is attentive to the risks to both sides of its dual mandate [price stability and maximum sustainable employment]”. Previously, the FOMC statement noted it was “highly attentive to inflation risks”. Indeed, Powell noted during his press conference he “would not like to see material further cooling in the labor market.”

The implication is Friday’s US July non-farm payrolls report will be a significant driver of US interest rate expectations. In the meantime, Fed funds futures have more than fully priced-in a 25bps rate cut in September and a total of almost 75bps of easing by year-end. In our view, solid US economic activity and modest disinflation suggest the Fed is unlikely to cut the funds rate as much as is currently priced-in. As such, there is room for an upward reassessment in Fed funds rate expectations in favour of USD and Treasury yields.

Today, the US July Challenger job cuts (12:30pm London), weekly jobless claims (1:30pm London), and ISM July manufacturing index (3:00pm London) are the domestic highlights. The ISM manufacturing index is projected to recover to 48.8 vs. 48.5 in June but risks are skewed to the downside. Most regional Fed surveys dipped in July and the US S&P Global manufacturing PMI fell to a 7-month low at 49.5 vs. 51.6 in June.

The Bank of England (BOE) interest rate decision and Monetary Policy Report take centre stage today (12:00pm London). The decision is live as the swaps market implies about 60% odds of a 25bps rate cut while a majority of analysts polled by Bloomberg anticipate a cut. We expect the BOE to pull the trigger and slash the policy rate 25bps to 5.00% in large part because headline CPI inflation has been at the BOE’s 2% target the last two months. In June, the vote to stay on hold was 7-2 with the 2 dissenters favouring a cut. As such, a rate cut today needs the support of just 3 more MPC members.

Granted, UK services CPI inflation is still running high at 5.7% y/y but forward-looking indicators point to a sharp slowdown in H2. In July, the CBI industrial trends survey showed selling prices plunged to the lowest level since December 2020 while the PMI services input and output cost inflation were the softest in more than three years.

Meanwhile, tighter UK fiscal policy can leave the BOE more room to ease policy. Chancellor of the Exchequer Rachel Reeves paved the way this week for higher taxes in the upcoming October 30 budget. Reeves warned of a £22bn (0.8% of GDP) funding shortfall that needed to be filled and announced emergency savings totalling £5.5bn. According to Reeves, “there will be more difficult decisions around spending, around welfare, and around tax.”

GBP can undershoot today if the BOE starts easing because a rate cut is not fully priced-in. Beyond the short-term, we remain bullish on GBP especially versus EUR supported in part by the UK’s tight fiscal/loose monetary policy mix.

Also worth watching today are: BOE Governor Andrew Bailey’s press conference (12:30pm), the BOE’s decision maker panel (DMP) survey of inflation expectations (2:00pm London) and a Q&A session with BOE Chief Economist Huw Pill (5:00pm London).

Crude oil prices edged higher on fears over a broader regional conflict in the Middle East. Iran has vowed revenge after Israel assassinated the political leader of Hamas in Tehran and killed a senior member of Hezbollah in Beirut. Nevertheless, China’s sluggish growth outlook remains a structural headwind for commodity prices. China reported poor private factory data overnight. The Caixin manufacturing PMI unexpectedly fell to 49.8 in July (consensus: 51.5) from 51.8 in June.

Czech National Bank meets today and is widely expected to cut rates 25bps to 4.50% (1:30pm London). At the last meeting June 27, the bank delivered a dovish surprise and cut rates 50bps to 4.75% vs. 25bps expected. However, Governor Michl said the pace of easing was likely to slow in the coming meetings and added that next move was likely to be either a 25bps cut or a pause. The swaps market is pricing almost 100bps of total easing over the next 12 months.