This certainly feels like the morning after the night before as the UK has a new political landscape. The same party is the government but now it is more powerful due to the fact it has a solid majority. As ever let us leave politics and move to the economic consequences and let me start with the Bank of England which meets next week. Let us remind ourselves of its view at its last meeting on the 7th of November.
Regarding Bank Rate, seven members of the Committee (Mark Carney, Ben Broadbent, Jon Cunliffe, Dave
Ramsden, Andrew Haldane, Silvana Tenreyro and Gertjan Vlieghe) voted in favour of the proposition. Two
members (Jonathan Haskel and Michael Saunders) voted against the proposition, preferring to reduce Bank
Rate by 25 basis points.
That was notable on two fronts. The votes for a cut were from external ( appointed from outside the Bank of England ) members. Also that it represented quite a volte face from Michael Saunders who regular readers will recall was previously pushing for interest-rate increases. Staying with the external members that makes me think of Gertjan Vlieghe who is also something of what Americans call a flip-flopper.
What has changed since?
The UK Pound
At the last meeting the Bank of England told us this.
The sterling exchange rate index had
increased by around 3% since the previous MPC meeting, and sterling implied volatilities had fallen back
So monetary conditions had tightened and this has continued since. The effective or trade weighted index was 79 around then whereas if we factor in the overnight rally it could be as high as 83 when it allows for that. In terms of individual currencies we have seen some changes as we look at US $1.34, 1.20 versus the Euro and just under 147 Yen.
This represents a tightening of monetary conditions and at the peak would be the equivalent of a 1% rise in Bank Rate using the old Bank of England rule of thumb. Of course the idea of the current Bank of England increasing interest-rates by 1% would require an episode of The Outer Limits to cover it but the economic reality is unchanged however it may try to spin things. Also this is on top of the previous rise.
There are consequences for the likely rate of inflation from the rise of the Pound £ we have just noted. The Bank of England was already thinking this.
CPI inflation remained at 1.7% in September
and is expected to decline to around 1¼% by the spring, owing to the temporary effect of falls in regulated
energy and water prices.
There are paths now where UK CPI inflation could fall below 1% meaning the Governor ( presumably not Mark Carney by then) would have to write an explanatory letter to the Chancellor.
A factor against this is the oil price should it remain around US $65 for a barrel of Brent Crude Oil but even so inflation looks set to fall further below target.
Also expectations may be adjusting to lower inflation in the offing.
Question 1: Asked to give the current rate of inflation, respondents gave a median answer of 2.9%, compared to 3.1% in August.
Question 2a: Median expectations of the rate of inflation over the coming year were 3.1%, down from 3.3% in August.
Question 2b: Asked about expected inflation in the twelve months after that, respondents gave a median answer of 2.9%, down from 3.0% in August. ( Bank of England this morning)
It is hard not to have a wry smile at the fact that those asked plainly are judging things at RPI type levels.
These have been rising driven by two factors. They have been rising generally across the developed world and an additional UK factor based at least partly on the likelihood of a higher fiscal deficit. The ten-year Gilt yield is 0.86% but more relevant for most as it influences fixed-rate mortgages is the five-year which is 0.64%.
The latter will bother the Bank of England as higher mortgage-rates may affect house prices adversely.
There was a time when Bank of England interest-rate moves fairly regularly responded to GDP data. Food for thought when we consider this week’s news.
The UK economy saw no growth in the latest three months. There were increases across the services sector, offset by falls in manufacturing with factories continuing the weak performance seen since April.
Construction also declined across the last three months with a notable drop in house building and infrastructure in October.
There is a swerve as they used to respond to quarterly GDP announcements whereas whilst this is also for 3 months it is not a formal quarter. But there is a clear message from it added to by the monthly GDP reading also being 0%.
Last week the Markit business survey told us this.
November’s PMI surveys collectively suggest that the UK
economy is staggering through the final quarter of 2019,
with service sector output falling back into decline after a
brief period of stabilisation……….Lower manufacturing production alongside an absence of growth in the service economy means that the IHS Markit/CIPS Composite Output Index is consistent with UK GDP declining at a quarterly rate of around 0.1%.
The Bank of England has followed the path of the Matkit business surveys before. Back in the late summer of 2016 the absent minded professor Ben Broadbent gave a speech essentially telling us that such sentiment measures we in. Although the nuance is that it rather spectacularly backfired ( the promised November rate cut to 0.1% never happened as by then it was apparent that the survey was incorrect) and these days even the absent minded professor must know that as suggested below.
Although business survey indicators, taken together, pointed to a contraction in GDP in Q4, the relationship between survey responses and growth appeared to have been weaker at times of uncertainty and some firms may have considered a no-deal Brexit as likely when they had
responded to the latest available surveys.
It is hard not to think that they will expect this to continue this quarter and into 2020.
Looking through movements in volatile components of GDP, the Committee judged that underlying growth
over the first three quarters of the year had been materially weaker than in 2017 and 2018.
If we look at the evidence and the likely triggers for a Bank of England Bank Rate cut they are in play right now. I have described above in what form. There are a couple of factors against it which will be around looser fiscal policy and a possible boost to business investment now the Brexit outlook is a little clearer. Policies already announced by the present government were expected to boost GDP by 0.4% and we can expect some more of this. Even so economic growth looks set to be weak.
Looking at the timing of such a move then there is an influence for it which is that it would be very Yes Prime Minister for the Bank of England to give the “new” government an interest-rate cut next week. Although in purist Yes Prime Minister terms the new Governor would do it! So who do you think the new Bank of England Governor will be?