If you had asked me a week ago, I would have said that a rate hike of 25 bps by the Bank of England in May was a high probability event. However, I had reckoned without the intervention of BoE Governor Carney who warned in a BBC TV interview last week that any such move was not a done deal. In his words, “there are other meetings over the course of this year” at which a rate hike can be delivered. As a consequence, the implied market probability attached to a 25 bps hike collapsed from 80% last Thursday to 52% today, thereby turning a near-certain rate hike into a toss-of-a-coin event (chart).
It would appear that Carney was trying to warn the market
that a string of weaker data argues against treating a May hike as a given. On
the one hand, CPI inflation has slowed more rapidly than the BoE expected in
its February forecast, coming in at 2.7% in Q1 versus a predicted 2.9%, with
the March rate slowing to 2.5% - the lowest in twelve months. Then there is the
likelihood that Q1 GDP growth will come in weaker than expected, posting a rate
of 0.2-0.3% q-o-q (an annualised rate of 0.8% to 1.2%).
Whilst these are mere statements of fact when viewed in isolation, in my view neither are good enough arguments to postpone the rate hike. For one thing the weak activity data are largely the result of cold weather at the beginning of March (remember the Beast from the East?). In the sense that this is a temporary factor, we should be looking through it to assess the underlying strength of the economy especially since: (a) there may well be a partial countermovement at the start of Q2 and (b) previous attempts by the ONS to measure the impact of a cold spell on activity growth have tended to be revised away (as occurred in Q1 2012 for example when the initial GDP estimate posted quarterly growth of -0.2% but now shows a rate of +0.6%). As for inflation, it has long been known that it would begin to slow after peaking in the early months of 2018. The BoE has been softening us up for a monetary tightening on the basis that inflation is above target but now that it is less above target than expected, it seems they are backing away from their long-held view.
Around the same time as Carney was making his comments, MPC member Michael Saunders argued forcefully that “the economy no longer needs as much stimulus as previously” and that in terms of the pace of hiking “’gradual’ need not mean ‘glacial’”. That was a direct contradiction of Carney’s view – as is the right of external MPC members – but it sends a conflicting message to both markets and individuals and very much calls into question the usefulness of forward guidance as a policy tool.
Forward guidance is designed to provide greater clarity about the central bank’s view and reduce uncertainty about the future path of monetary policy whilst delivering a robust policy framework. The Governor’s intervention just three weeks before the May rate decision does nothing to enhance clarity; has introduced more, not less, certainty about the path of interest rates and the differing messages from policymakers suggests that the policy framework is anything but robust. It is not as if this is the first time the Governor has blown a hole in the communications strategy. His comments at the Mansion House speech in June 2014 hinted strongly at a rate hike that did not materialise and led MP Pat McFadden to dub Carney “the unreliable boyfriend.”
As I have argued before (here), policymakers are making a mistake by focusing on the change in interest rates conditional on current economic circumstances when what really matters is the level of interest rates conditional on general economic conditions. Even if Brexit is curbing economic activity, as Carney argued, the economy is by no means falling off a cliff and therefore does not need interest rates at levels consistent with the threatened meltdown of 2009.I fully understand policymakers’ caution. After all, it is not just the markets that they have to convince: It is those individuals whose economic prospects are dependent on the path of interest rates. But I cannot help thinking that on credibility grounds, the MPC would be better advised to deliver the May rate hike they had strongly trailed, and allow themselves a more fierce debate about whether there is a need for additional tightening. As it is, they almost now cannot win. If they do raise rates next month it will call into question why Carney needed to wade into the debate. But if they don’t, it will raise questions about the message that the BoE was communicating in the two months prior to last week. Silence can be golden.
Whilst these are mere statements of fact when viewed in isolation, in my view neither are good enough arguments to postpone the rate hike. For one thing the weak activity data are largely the result of cold weather at the beginning of March (remember the Beast from the East?). In the sense that this is a temporary factor, we should be looking through it to assess the underlying strength of the economy especially since: (a) there may well be a partial countermovement at the start of Q2 and (b) previous attempts by the ONS to measure the impact of a cold spell on activity growth have tended to be revised away (as occurred in Q1 2012 for example when the initial GDP estimate posted quarterly growth of -0.2% but now shows a rate of +0.6%). As for inflation, it has long been known that it would begin to slow after peaking in the early months of 2018. The BoE has been softening us up for a monetary tightening on the basis that inflation is above target but now that it is less above target than expected, it seems they are backing away from their long-held view.
Around the same time as Carney was making his comments, MPC member Michael Saunders argued forcefully that “the economy no longer needs as much stimulus as previously” and that in terms of the pace of hiking “’gradual’ need not mean ‘glacial’”. That was a direct contradiction of Carney’s view – as is the right of external MPC members – but it sends a conflicting message to both markets and individuals and very much calls into question the usefulness of forward guidance as a policy tool.
Forward guidance is designed to provide greater clarity about the central bank’s view and reduce uncertainty about the future path of monetary policy whilst delivering a robust policy framework. The Governor’s intervention just three weeks before the May rate decision does nothing to enhance clarity; has introduced more, not less, certainty about the path of interest rates and the differing messages from policymakers suggests that the policy framework is anything but robust. It is not as if this is the first time the Governor has blown a hole in the communications strategy. His comments at the Mansion House speech in June 2014 hinted strongly at a rate hike that did not materialise and led MP Pat McFadden to dub Carney “the unreliable boyfriend.”
As I have argued before (here), policymakers are making a mistake by focusing on the change in interest rates conditional on current economic circumstances when what really matters is the level of interest rates conditional on general economic conditions. Even if Brexit is curbing economic activity, as Carney argued, the economy is by no means falling off a cliff and therefore does not need interest rates at levels consistent with the threatened meltdown of 2009.I fully understand policymakers’ caution. After all, it is not just the markets that they have to convince: It is those individuals whose economic prospects are dependent on the path of interest rates. But I cannot help thinking that on credibility grounds, the MPC would be better advised to deliver the May rate hike they had strongly trailed, and allow themselves a more fierce debate about whether there is a need for additional tightening. As it is, they almost now cannot win. If they do raise rates next month it will call into question why Carney needed to wade into the debate. But if they don’t, it will raise questions about the message that the BoE was communicating in the two months prior to last week. Silence can be golden.
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