A Bank of England interest-rate cut is now in play

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
somewhat,

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.

Inflation

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.

Gilt Yields

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.

The economy

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.

Comment

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?

 

 

 

 

14 thoughts on “A Bank of England interest-rate cut is now in play

  1. Great blog as usual, Shaun.
    Donald Trump is already talking about a massive new trade deal between the UK and the US after the Conservative win. The revision to the USMCA was signed just three days ago, and is likely to come into force next year sometime. It may behoove people in the UK to watch how it unfolds since the US Trade Representative is likely to want clauses in that agreement to also appear in a US-UK agreement. In particular, Chapter 33 of the USMCA, Macroeconomic Policies and Exchange Rate Matters, is unprecedented in seeking to keep the trading partners from engaging in currency wars with each other. It will have to be seen to what degree it is used and how much it constrains the sovereignty of Mexico and Canada in conducting their own monetary policies. However, in principle, discouraging currency wars among nations is a good thing, not a bad thing, so people should keep an open mind about Chapter 33, or the possibility of a similar chapter in a US-UK trade agreement.

    • Hi Andrew and thank you

      Yes the Donald does seem to be on the case of a trade deal with the UK. I would say we could piggy back on your new one but of course unlike you and Mexico we do not have a land border with the US. As to the agreement I wait to see how the Donald responds to this.

      “Each Party confirms that it is bound under the Articles of Agreement of the IMF to avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage.
      Each Party should:
      (a) achieve and maintain a market-determined exchange rate regime;

      (b) refrain from competitive devaluation, including through intervention in the foreign exchange market; and

      (c) strengthen underlying economic fundamentals, which reinforces the conditions for macroeconomic and exchange rate stability.”

      Has it been received well in Canasa?

      • Thanks for your reply, Shaun. The first passage you quoted from Chapter 33 is taken almost verbatim from the 2015 Joint Declaration of the Macroeconomic Policy Authorities of Trans-Pacific Partnership Countries: ”Each Authority confirms that its country is bound under the Articles of Agreement of the International Monetary Fund (IMF) to avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage.” The passage you quote after that is also very similar to what appears in the TPP document, and both have the same stricture against competitive devaluation. As Stephanie Segal noted: “a significant difference between USMCA’s Chapter 33 and TPP’s Joint Declaration is that Chapter 33 is included within the core text of the USMCA itself, which means that certain commitments under the agreement are legally enforceable.” As you know, Trump withdrew the US from the TPP and the Joint Declaration disappeared from the successor CPTPP agreement, which would suggest it was of considerable importance to the Americans but not to the other countries negotiating the TPP. . I would assume Trump endorses the clauses you quoted or he would not have allowed his Trade Representative to make them part of the main agreement.
        This seems to have been snuck into the USMCA at the last moment in September 2018. Nobody seemed to have heard about it thing was about it until after the agreement was signed and the reaction to it in Canada at least was mostly negative. The left-leaning journalist Duncan Cameron wrote on October 1, 2018: “From now on Canada gets to sit down with the U.S. whenever they think our dollar is too low and admit to currency manipulation. So much for central bank independence.” Chapter 33 wasn’t affected by the renegotiation of the agreement, so it has been pretty much ignored in discussing the revised USMCA.

  2. Hi Shaun

    Great article as always. Just as the embattled consumer starts to get some respite from imported inflation via a strengthed pound then Carnage will either talk down the pound or reduce rates. Its almost like clockwork.

    Also no surprise that housebuilders we up 10%+ today. The housing market must be protected at all costs.

    On a slightly different note, at least this isn’t happening in the uk…….. yet:

    http://smh.com.au/business/markets/greeks-set-to-face-heavy-fines-if-they-don-t-spend-30-per-cent-of-their-income-electronically-20191209-p53i14.html

    Thanks

    • Hi Anteos and thank you as I had not spotted that.

      This seems harsh at that level.

      “If a Greek earned €1,000 per month and only paid 15 per cent of their income electronically, they would pay a fine of around €400 every year, for example.”

      Also what could go wrong?

      ” The government is confident it will not drive more workers into the country’s booming shadow economy and tempt them to understate their earnings, a key problem in Greece.”

      I am not sure why it is necessary as according to Christine Lagarde on Thursday things are going really well in Greece…..

  3. The tory win was bound to be a shot of adrenalin for both shares and the £ Corbyn policies would have hit utilities and even many large listed companies giving more shareholder representation, which in part was a good idea but could create interference.

    I think the euphoria will dissipate as the weeks and months take stock next year as world growth is still slowing.

    https://www.ft.com/content/7333b8a2-1d22-11ea-97df-cc63de1d73f4

    But todays blog is about intertest rates possibilities and I think next week could well see a cut of 0.25% which I think was behind the curve in any event.

    Borris argued a Corbyn government may see higher interest rates, well that was my understanding and it would bolster his ratings further.

    With interest rates falling around the globe I would be disappointed if rates were not cut, the Tories need to do everything they can to prevent the economy weakening further.

    One would have though an interest cut would have weakened the £ but with interest rates falling around the globe that points to why the £ is still strong.

    The footsie 250 up 4% as I write, it had been higher and the footsie 100 up 1.7% due to less profits on dollar earners.

    So what are my predictions on an interest rate decision?

    Next week a cut of 0.25%

    January February a further 0.25% cut

    May 0.15% cut

    Sorry to all those who want lower house prices, this wont happen in the short term imo.

      • Hi Peter

        The UK does have a fair bit of fiscal headroom. Whether using it is a good idea is another matter depending a lot on what it is used for.

        As to interest-rates we will have to see as maybe the new Governor will want to cut them. But by the end of the day things had changed a bit as the ten-year Gilt yield fell to 0.78% so maybe markets noted my analysis.

  4. Hi Forbin,
    Your “friend” Mark will likely bow out with an interest rate cut before he leaves for his new job as Emperor of the money soaked shores of Climate Change Land, add into that the possibility of another Tory subsidy or two for the housing market to keep the “Feelgood” factor going next year and you might be pleasantly surprised come the spring, and give you an “out” from your current predicament.And QE will no doubt be re-starting some time to follow suit with the Fed.Eventually buying corporate bonds and equities a la ECB.

    After all, we cannot allow the £ to continue appreciating against the Euro as it keeps moving away from the intended target of our accepting it as our new currency.

    Another 20-30% depreciation minimum is required IMHO, before we get there, the wheels are already in motion, knowing what has happened to “BREXIT” and Johnson’s appointment together with the intentions of our “masters,” I feel a bit like someone sitting on my couch on Xmas day watching an Agatha Christie mystery who has already seen the last ten minutes and knows “who dunnit”, the next one hour fifty minutes is very amusing in that it is fascinating watching the twists and turns and red herrings presented as facts before the final denouement.

    I never usually give timeframes for my predictions(Woodford Patient reached its 29p target by the way), but on this occasion I think we will be watching the replacement of our currency some time in the next FIVE YEARS, maybe less than that.

    • Does Mark have any friends ? 😉

      I am of the opinion that the next possible 5 years of Conservative government will determine if they will govern for the next 15 years.

      ok this is politics but economics too

      if they cannot deal effectively and foul up then they will get booted out and the next HMG will rejoin the EU and the euro as you suggest as we’ll be right up that creek ……..

      if they’re not kitten soft and they can pull it off , then,,,,,,,,,

      Forbin

  5. Hi Shaun

    I can’t see the case for an interest rate cut now for two reasons.

    The first is that Brexit has created uncertainty and the election will have dispelled ate least some of this. The uncertainty to date has I’m sure had an impact on activity by reducing spending but some of the spending is only postponed and not lost completely. It wouldn’t surprise me to see an uptick in activity in the first quarter of next year due to the release of this postponed spending which, in respect of interest rates would indicate a “wait and see” stance until the smoke clears.

    The second reason is that public spending may well increase despite the fact that the Tory manifesto gave very few commitments. The fact that the Tories have been “lent” votes by many of the Northern Labour constituencies may well lead to more spending in order to retain those votes in future. More spending means more pressure on yields.

    However, as a countervailing argument, I remain of the view that we are well overdue a recession and are also likely to get a financial crash as both public and private debt levels are way above what they were in 2008. Of course Carney may well give a valedictory wave by showing us again what he does best – reducing rates – but, as before, the justification for doing so may be remarkably thin, not that that has stopped him in the past.

    In my view the smart thing to do is wait and see.

      • Bob,
        Poor PMI figures out this morning strengthens mar argument for a rate cut this weak, and as for Europe data this morning is weaker than expected, for German manufacturing, Italian CPI and Europe Manufacturing/PMI.

        It takes time for interest rates cuts to have an effect I think the BOE are behind the trend.

  6. As we approach the monetary event horizon, the natural laws of economics don’t always apply. Under a Newtonian-type concept, Bank Rate is reduced to temper appreciation and the related effective monetary tightening. But we shouldn’t be at all surprised if a rate reduction actually results in currency appreciation. And of course, the Pointy Heads at the Central Bank will deploy the counter factual excuse to greatest effect: that such appreciation would have been far more without their expert stewardship.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.