Carney’s market bluff

So, it seems that everyone was expecting Mark Carney this week, the new Bank of England governor, to put his foot on the pedal and increase the asset-purchase level from the current £375 billion. Unfortunately, for all sterling bears (the direct opposite of what we have been in recent months – resolute sterling bulls), that hasn’t happened.

Previously being head of the Bank of Canada and tasked with saving Britain from its current low-growth-high-inflation state, Carney was expected to wave his magic monetary want and, with additional cash injections, mirror what our friends “Helicopter” Ben Bernanke are doing across the pound (and Shinzo Abe in Japan). Carney however kept the current asset package unchanged at £375 billion and the benchmark interest rate at 0.5pc. Investors reacted by closing short positions on sterling and opening new long positions, especially against the dollar. After hitting a low at 1.5205 intraday, the pound climbed more than 300 pips against the dollar and it is currently trading above 1.5550. I hope readers of our magazine read our piece here on page (68) http://issuu.com/spreadbetmagazine/docs/spreadbet_mag_v19_generic and positioned themselves ahead of the pack to profit handsomely.

Sterling chart YTD

Instead of flooding the market with fresh money, Carney seems more concerned with improving communications with the market and with better managing expectations. The new BOE governor defined a qualified pledge to keep interest rates low and the current asset-purchase program in place, at least until the country’s jobless rate falls to 7pc. Following in Bernanke’s footsteps, Carney is trying to improve communications of the central bank’s intentions and to make current monetary policy dependent on real goals.

But, unlike what happens in the US where quantitative easing is taken to the extreme, Carney doesn’t seem willing to expand the current pace of monetary easing. In fact, that’s probably not even an option for him. Why?

Firstly, inflation in the UK isn’t below 2pc as in the US but rather much above the central bank’s target and has been for more than 4 years now. Any attempt at expanding the monetary base would most certainly result in exploding prices just as the economy is reaching escape velocity, and consequently loss of credibility for the BOE – something we doubt Carney wants in his first term. Such a policy move would likely have a large negative impact across the economy too.

Secondly, Carney significantly raised growth forecasts for 2014 from 1.9% to 2.7%. It would seem odd to increase the asset-purchase program after such a growth upgrade.

Thirdly, let’s also not forget that the BOE, as with the ECB, isn’t a dual-mandated central banks as the Federal Reserve is. Even though growth should be taken into account when setting monetary policy, price stability is the number one goal. It’s true that George Osborne tweaked the BOE’s mandate earlier this year to allow for the bank to continue ignoring inflation for a while, but that didn’t change the single mandate towards inflation however. The BOE isn’t an extension of any government cabinet, for now…

Fourthly, it would not be an easy task to change the minds of other MPC members and who are, as a majority, opposed to more QE (as Mervyn King would attest.

Investors quickly understood the implications of Carney’s message and which, at first flush, appears to be contrary to what he was trying to achieve. With an improved economic picture and current unemployment rate at 7.8%, it may in fact be a short route until the 7% threshold is reached, probably during next year, which means not only the £375bn package won’t see one more penny being added, but also that interest rates may start rising again as soon as the first quarter of 2015.

We think sterling will be a standout performer over the remainder of this year, particularly against the Euro as forward interest rate differentials increase and economic momentum increases in the UK relative to the content. As such, we are positioned accordingly in our macro fund. Click below for more details.

R Jennings, CFA, Fund Manager Titan Investment Partners