How the Bank of England eased monetary policy yesterday

Yesterday something happened which is rather rare a bit like finding a native red squirrel in the UK. What took place was that part of the Forward Guidance of the Bank of England came true.

At its meeting ending on 1 November 2017, the
MPC voted by a majority of 7-2 to increase Bank Rate by 0.25 percentage points, to 0.5%.

Not really the “sooner than markets expect” of June 2014 was it? Also of course it was only taking Bank Rate back to the 0.5% of them. Or as it was rather amusingly put in the comments section yesterday the Bank of England moved from a “panic” level of interest-rates to a mere “emergency” one!

Problems

It was not that two Monetary Policy Committee members voted against the rise that was a problem because as I pointed out on Wednesday they had signalled that. It was instead this.

All members agree that any future increases in Bank Rate would be expected to be at a gradual pace and to a limited extent.

In itself it is fairly standard central bank speak but what was missing was an additional bit saying something along the lines of “interest-rates may rise more than markets expect”. Actually it would have been an easy and cheap thing to say as expectations were so low. This immediately unsettled markets as everyone waited the 30 minutes until the Inflation Report press conference began. Then Governor Carney dropped this bombshell.

Current market yields, which are used to condition our forecasts, incorporate two further 25 basis point increases over the next three years. That gently rising path is consistent with inflation falling back over the next year and approaching the target by the end of the forecast
period.

This was a disappointment to those who had expected a series of interest-rate rises along the lines of those from the US Federal Reserve. Some may have wondered how a man who plans to depart in June 2019 could be making promises out to 2021! Was this in reality “one and done”?

Added to this was the concentration on Brexit.

Brexit remains the biggest determinant of that outlook. The decision to leave the European Union is already having a noticeable impact.

The latter sentence is true with respect to inflation for example but like when he incorrectly predicted a possible recession should the UK vote leave the Governor seems unable to split his own personal views from his professional  role. This gets particularly uncomfortable here.

And Brexit-related constraints on investment and labour supply appear to be reinforcing the marked slowdown that has been evident in recent years in the rate at which the economy can grow without generating inflationary pressures.

The new “speed limit” for the UK economy of 1.5% per annum GDP growth comes from exactly the same Ivory Tower which told us a 7% unemployment rate was significant which speaks for itself! Or that wage increases are just around the corner every year. In a way the fact that the equilibrium unemployment rate is now 4.5% shows how wrong they have been.

The UK Pound

The exchange-rate of the UK Pound £ had been slipping before the announcement. As to whether this was an “early wire” from the long delay between the vote and the announcement or just profit-taking is hard to say. What we can say is that the Pound £ dropped like a stone immediately after the announcement to just over US $1.31 and towards 1.12 versus the Euro. Later after receiving further confirmation from the Inflation Report press conference it fell to below US $1.306 and to below Euro 1.12.

If we switch to the trade-weighted or effective index we see that it fell from the previous days fixing of 77.76 to 76.44. If we use the old Bank of England rule of thumb that is equivalent to a Bank Rate reduction of around 1/3 rd of a percent.

UK Gilt yields

You might think that these would rise in response to a Bank Rate change but this turned out not to be so. The cause was the same as the falling Pound £ which was that markets had begun to price in a series of increases and were now retreating from that. Let us start with the benchmark ten-year yield which fell from 1.36% to 1.26% and is now 1.24%. Next we need to look at the five-year yield because that is often a signal for fixed-rate mortgages, It fell from 0.83% to 0.71% on the news.

The latter development raised a smile as I wondered if someone might cut their fixed-rate mortgages?! This would be awkward for a media presenting mortgage holders as losers. This applies to those on variable rates but for newer mortgages the clear trend has been towards fixed-rates.

But again the conclusion is that post the decision the fall in UK Gilt yields eased monetary policy which is especially curious when you note how low they were in the first place.

This morning

Deputy Governor Broadbent was sent out on the Today programme on BBC Radio 4 to try to undo some of the damage.

BoE’s Broadbent: Anticipate We May Need A Couple More Rate Rises To Get Inflation Back On Track – BBC Radio 4 ( h/t @LiveSquawk )

The trouble is that if you send out someone who not only looks like but behaves like an absent-minded professor the message can get confused. From Reuters.

The Bank of England’s signal that it may need to raise interest rates two more times to get inflation back toward the central bank’s target is not a promise, Bank of England Deputy Governor Ben Broadbent said on Friday.

Then matters deteriorated further as “absent-minded” Ben claimed that Governor Carney had not said that a Brexit vote could lead to a recession before the vote and was corrected by the presenter Mishal Husain. I do not want to personalise on Ben but as there have been loads of issues to say the least about Deputy Governors in the recent era from misrepresentations to incompetence what can one reasonably expect for a remuneration package of around £360,000 per annum these days?

Here is a thought for the Bank of England to help it with its “woman overboard” problems. The questioning of Mishal Husain was intelligent and she seemed to be aware of economic developments which puts her ahead of many who have been appointed……

Comment

There is a lot to consider here as we see that the Bank Rate rise fitted oddly at best with the downbeat pessimism of Governor Carney and the Bank of England. Actually in many ways  the pessimism fitted oddly with the previous stated claim that a Bank Rate rise was justified because the economy had shown signs of improvement. On that road the monetary score is +0.25% for the Bank Rate rise then -0.33% for the currency impact and an extra minus bit for the lower Gilt yields leaving us on the day with easier monetary policy than when the day began.

Today saw another problem for the Bank of England as some good news for the UK economy emerged from the Markit ( PMI) business surveys.

The data point to the economy growing at a
quarterly rate of 0.5%, representing an
encouragingly solid start to the fourth quarter.

How about simply saying the economy has shown strengthening signs recently and inflation is above target so we raised interest-rates? Then you keep mostly quiet about your personal views on the EU leave vote on whichever side they take and avoid predictions about future interest-rates like the Bank of England used to do. Indeed if you have an Ivory Tower which has been incredibly error prone you would tell it to keep its latest view in what in modern terms would be called beta until it has some backing.

Oh and as to the claimed evidence that private-sector wages are picking up well the official August data at 2.4% does not say that and here is a song from Earth Wind and Fire which covers the Bank of England’s record in this area.

Take a ride in the sky
On our ship, fantasize
All your dreams will come true right away

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24 thoughts on “How the Bank of England eased monetary policy yesterday

  1. As many in the media commented yesterday there was no economic reason for this increase; it was largely a matter of BOE credibility; furthermore there will be very little follow through which confirms the stupidity of it.

    One thing you didn’t mention is that the BOE also said that inflation was peaking at 3.2% and would decline to around 2.15% in three years time. The effect of two further (IMV never) small increases in rates by a total of 0.5%, given the lags in monetary policy, does not square with a fall in inflation of this magnitude so what is going on? As the BOE cannot know anything about fiscal policy in the next three years it cannot be this; if anything I would have thought we would be spending more which might add pressure to inflation but but that would be as a result of a downturn which they do not forecast.

    This leaves the exchange rate, which, in view of their doubts about Brexit, must err on the side of depreciation but is 0.5% going to make much difference over two years? Again I can’t see it.

    It seems to me that they are having to invent ever more absurd stories to cover the basic fact that they haven’t a clue and are just making it up as they go along.

    • Or they simply have to invent more absurd stories(which keep contradicting previous statements) in order to conceal the fact they are trying to keep the housing market up at these elevated levels and that it is this and this alone that is driving policy.

      The importance and the significance of the removal of the “we believe that the rate trajectory is likely to be somewhat higher than the market expects” cannot be understated.
      This bluff, previously trotted out became something of a joke(especially on here) but to the forex markets it would have meant a very remote possiblity still exists, this would have made those who would have shorted sterling think twice.

      Now Carney has removed it, he has signalled to the market that one of the main pillars of support for the currency will be removed, thus virtually invitng speculative shorts to go all in on the pound.

      The pound is now the veritable baby Impala isolated from its mother desperately trying to avoid the circling lions – and now Carney has just broken one of its legs.

      The resultant drop in sterling will cause more of the inflation Mr Carney is trying to convince us is temporary(and also prove his forecasts were wrong again), thus putting more pressure to him to raise rates – which he has clearly stated he is unwilling to do – thus causing a further fall in sterling.

      This vicious circle combined with the BREXIT negotiations farce is going to be disastrous for the pound, basics and food costs will soar causing further loss in spending power for already struggling households that have seen their real incomes either flat or falling ove rthe last ten years.

      What a mess the Bank of England have created, and the mainstream media report all this as if it is just “market forces” or was totally unpredictable.

    • Hello, BobJ. I doubt that three-year ahead forecasts from any central bank can be taken seriously. However, if you read my comment below, exit effects suggest the Bank is right in thinking that the inflation rate will peak in October and will be lower in the first half of 2018.

      • Hi Andrew

        I agree with you here and that was my point yesterday. If inflation is going to come down more of its own accord, including disappearing from the index, then what is the rationale for increasing rates? By their own admission inflation will be down close to the policy level of 2% without the effects of the two later, and theoretical, increases which have been pencilled in and will not have had time to take effect anyway. The argument about wages picking up was a smokescreen in my view and was just an excuse; I can’t see any substantial second round effects.

        • If they make 2 further raises in H1 next year there is plenty of time for an effect on GDP and sufficient time for an effect on inflation – reread your monetary policy theory with reference to lag times..

          As to the rationale to increasing rates? easy – wriggle room when the next recession hits.

  2. Hi Shaun
    Politics is the art of looking for trouble, finding it
    everywhere, diagnosing it incorrectly and applying the
    wrong remedies. Groucho Marx
    Why are comedians who became famous acting
    like buffoons actually pretty bright?

    JRH

  3. Great blog as always, Shaun.
    Arthur Cox complained yesterday about the jargon that Carney used in the press conference after the release of the Inflation Report. The BoE has predicted that the CPI inflation rate would be higher in October than in September but would fall after that. The reasoning is straightforward. The 12-month rate of price change that the BoE targets is a function of 12 ratios for monthly price change. In November 2016 the month-to-month inflation rate was 0.2%, which doesn’t look much, but is stronger than usual for November. If the November 2017 month-to-month inflation rate is closer to normal for the month, the impact of the November 2016 inflation rate exiting the annual rate will be to pull the annual inflation rate down. This holds true for all the months from November 2016 to May 2017, January and April excepted, where the inflation rate was stronger than usual for that calendar month. But when Carney sought to explain it, he just blurted out something about the base effect and wouldn’t go further, as if these were such arcane matters no press conference journo could possibly understand.
    The phrase “base effect” is a garbage term that seems to have been first used by Statistics Canada in its October 2002 CPI update.
    http://www.statcan.gc.ca/pub/62-001-x/62-001-x2002010-eng.htm
    There was a big drop in energy prices in October 2001, the month following the 9/11 terrorist atrocities, enough to bring the October 2011 month-to-month inflation rate show a decrease of 0.5%. When this dropped out of the annual inflation rate in October 2002, it shot up from 2.3% in September to 3.2% in October. This should have been called an exit effect, but for some reason StatCan chose to call it a base effect, concentrating on the October 2002 inflation rate being calculated on a lower October 2001 base than the September 2002 base, when this was just an artifact of the exceptional October 2001 monthly inflation rate. The phoniness of this terminology is immediately obvious if you think that there would have been an even stronger jump in inflation if October prices usually rose by 10% but in October 2001 had not moved at all. Then the big exit effect pushing inflation up would have been accompanied by no change in the base at all. For some reason this trashy term has metastasized all over the world since then, as far away as India, and Carney has been a serial abuser of it.

    • Hi Andrew and thank you

      As to the use of the phrase “base effects” the horse has bolted I think as you say. I can hear Mario Draghi of the ECB saying it as I type this. Moving to your methodology I completely agree and the other method I use as a check is to look down the chain to past producer price numbers to get an idea of inflationary pressure from that source.

  4. Reading these comments does make me wonder how we ever thought this man was a great hero. He clearly is clueless and, as Shaun says, is muddling up his personal distaste for Brexit with BoE policy. I struggled as to his appointment and can think of only three reasons why he got the job:
    1. He looks the part;
    2. As with football managers, it seems more exotic to take on overseas candidates; and
    3. He was at Goldman Sachs.
    IMHO, the last point clinched it.
    Does anyone else have a better reason why he was picked?

  5. Hello Shaun,

    Whatever MC says – well that aint why is it ?

    anyone here hazard a guess as to the real reason?

    perhaps the IR is not an economic tool but a political one?
    ( Shaun wisely does not do politics but some commentators may help me here )

    Forbin

    • Hi Paul

      That must be especially awkward for Mark Carney as I recall him telling us the “lower bound” was 0.5% so there may be no room for manoeuvre. More seriously we did have Ben Broadbent referring to 0.25% as the lower bound in the Inflation Report presser which still does not leave much room. Perhaps we will get Bank Rate changes of 0.1% after all.

      Sadly nobody challenged the absent-minded professor by asking how places like Sweden ( -0.5%), Switzerland ( -0.75%) and the ECB ( -0.4%) have managed to keep interest-rates below his lower bound.

  6. I just don’t get these commentators above – if you are an inflation-phobe Carney is your man – average inflation rate under his tenure has been less than 2%, below his target of 2.5%, pretty much the best period since before the war. During that period growth has been not particularly good. The only way to get even lower inflation would be to have hiked interest rates, which would have killed the economy even more.

    And Sean – what economic model are you using where an increase in the base rate “should” cause an increase in gilts rates? If the central bank is increasing base rates, it is to lower future inflation, which should mean gilts rates should fall upon the announcement. This is a confusion I see again and again in the media.

    • Economics 101 states that base rate is increased when the Central Bank thinks there is a danger of the economy “overheating” i.e inflation starts increasing eventually overtaking growth resulting in negative “real growth” aka a recession.

      So, it’s about CB inflation expectations.”Normally”, bond markets would heed this and start selling bonds to either move into equities as this suggests a currently strong economy (albeit be ready to jump out quickly further down the line if overheating signs materialise) or they’ll rotate out of longer dated to shorter dated bonds resulting in a “normal” yield curve where longer dated bonds command higher yields than shorter dated ones. Currently, the yield curve is inverted where longer dated bonds are fetching less yield than shorter ones.

      However, in the new reality of the last 10 years the bond markets pay lip service to the CB’s as the CB’s have covered themselves in something very different to glory in their predictive capabilities and their (mis)handling of the credit crunch era. Therefore, nowadays it doesn’t make sense to consult your economics text books any more due to the breakdown of trust and relationships in the economics world.

      As for the other commenters they’re just moaners and Establishment haters.

      Their current thinking is that no recovery has been staged, therefore why raise and they are petrified about the value of the £ which they think will sink lower because Carney didn’t signal rate increases to infinity and beyond, although, of course, if he did, they would then complain that that he had just shot the bottom out of investment as savers would wait for further rate increases in preference to investing which in turn would lead to a dearth of investment and thence to falling GDP as productive capacity was not increased due to underinvestment.

      In short they’re complainers – the water’s never “just right” it’s always too hot or too cold if they think the Establishment had a hand in running the water.

  7. “But again the conclusion is that post the decision the fall in UK Gilt yields eased monetary policy which is especially curious when you note how low they were in the first place”

    Nothing at al curious about it – Bond investors reaching for yield so they happily pay higher prices on the back of an increase in rates announcement. .

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