Bank of England – Trick rather than treat

The Bank of England (BoE) hiked rates 25bp yesterday for the first time in a decade, as expected, with recent domestic and global macro data seemingly helping the Monetary Policy Council inch over the rate-hiking start line.

But that was not real story, with financial markets always likely to look beyond the headline decision and focus instead on the underlying message.

Markets’ dovish reaction in the past 24 hours suggests that they zeroed in on BoE Governor Carney’s view that future rate hikes would be gradual and limited.

The Sterling Nominal Effective Exchange Rate is down 1.4% to the bottom of a 5-week range and markets are now pricing only a 34% probability of a 25bp hike in February.

Carney’s cautious outlook for the policy rate’s path is in line with my expectations that macro data and the cloak of uncertainty which surrounds Brexit will limit the need and room for the BoE to tighten monetary policy.

Fundamentally, the UK economy remains fragile, with lacklustre GDP growth of only 1% in Q1-Q3 2017 lagging growth in other G7 economies, and the medium-term outlook remains uncertain at best, in my view.

Weak retail sales and household consumption growth of only 0.5% in H1 is clearly acting as a drag on overall economic growth.

A key reason is that growth in economy-wide real earnings has slowed sharply in the past two years, in turn the by-product of slowing growth in employment and real earnings.

Moreover, the household savings rate is an already very low 6% while commercial banks are looking to tighten lending standards and pass on yesterday’s rate hike to borrowers.

With this backdrop and likely slowdown in imported inflation, core and headline CPI-inflation may be close to peaking, in my view, although there is of course the no small-matter of Brexit, a known unknown of considerable magnitude.

Governor Carney’s clear message that the BoE may not need to hike much to get inflation back down to 2% in coming years is somewhat reminiscent of the US Federal Reserve’s policy stance in 2015 and 2016.

It is possible, in my view, that the BoE’s rate hiking cycle could mirror the Fed’s with the BoE only delivering one (or perhaps two) hikes in 2018, in which case markets may need to further reduce their expectations of a February 2018 rate hike.

Read the full article on my website.

Bank of England rate cut – Seven years in the making

For the past few years, the Bank of England’s MPC meetings have been pretty straightforward affairs, with the policy rate firmly on hold at its record low of 0.5%.

But the referendum result has dramatically changed the British political landscape and amplified the uncertainty over the near and long-term outlook for the UK economy.

A 25bp rate cut today is perhaps not quite the foregone conclusion which markets are almost fully pricing in. The BoE could today make valid arguments both to support a 25bp rate cut and no change.

On balance, however, I think the BoE has more compelling reasons to cut its policy rate 25bp today than to leave it on hold.

First, BoE Governor Carney has made clear that a rate cut was potentially on the cards, making it harder for him to backtrack.

Second, the British economy was showing clear signs of weakness even before the referendum.

Third, there are signs that economic and political uncertainty post referendum are already having a negative impact on consumption, investment and confidence.

Finally, the BoE may be the only game in town for now as there is limited room for domestic fiscal policy and global monetary policy reflation.

But cutting the policy rate to 25bp or even zero is clearly no panacea to the challenges which the UK faces in coming weeks, months and perhaps even years and there are valid counter-arguments as to why the BoE may leave its policy rate on hold today.

These include that the BoE should save its (limited) bullets and wait for more hard data, a BoE rate cut would set in motion self-fulfilling prophecy, the BoE should balance post-referendum chaos with a steady policy rate, the global equity market rebound has removed the sense of urgency and a rate cut could trigger uncontrolled Sterling depreciation.

Regardless of today’s decision, the BoE’s accompanying minutes will likely try to capture this new paradigm.

A rate cut today would still leave the BoE the option of cutting rates again at its 4th August meeting but negative interest rate policy and/or quantitative easing are still likely to be measures of last resort.

Read ‘Bank of England rate cut – Seven years in the making‘ in full.

FED TO LEAD BOE INTO SLOW AND GRADUAL RATE HIKES

The over-riding consensus amongst portfolio managers, analysts and finance specialists surveyed is that the US Federal Reserve will start hiking its policy rate before the Bank of England (BoE).

Respondents are less confident about the exact timing of the start of the Fed and in particular BoE hikes. The consensus forecast is for the Fed to pull the trigger in September but for the BoE to wait till Q1 2016. There is an overwhelming view that the rate hiking cycles will be slow and gradual, particularly in the UK, with the Fed and BoE expected to hike rates by only 96bps and 67bps, respectively, between now and end-2016.

The survey consisted of five sets of questions and was open from 27th May (12:00) to 30th May (12:00). Respondents could chose to skip one or more questions. 61 respondents filled in the survey, four sets responses were disregarded due to inconsistent answers. 40% of the 57 respondents are portfolio managers, 20% analysts/strategists with the remainder being finance and industry specialists. Please see Appendix for complete survey data. Thank you to all who responded to this survey.

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