MINUTES WATCHED FOR SIGNS OF DISSENT
Minutes to the Bank of England’s (BoE) meeting on 1 August will be released on Wednesday; they are expected to reveal how much support governor Mark Carney had for launching forward guidance – which we know was discussed at the regular meeting held one week prior to the announcement.
Last Wednesday the Monetary Policy Committee (MPC) stated that it intends “not to raise Bank Rate from its current level of 0.5% at least until the Labour Force Survey headline measure of the unemployment rate has fallen to a threshold of 7%,” unless the following three “knock-outs” are breached:
– it is more likely than not, that CPI inflation 18 to 24 months ahead will be 0.5 percentage points or more above the 2% target;
– medium-term inflation expectations no longer remain sufficiently well anchored;
– the Financial Policy Committee (FPC) judges that the stance of monetary policy poses a significant threat to financial stability.
The minutes will be closely watched for any signs of dissent; if the release reveals any doubts among committee members, markets will likely be rattled as they question whether the BoE will hold rates low throughout the entire duration of the forecast horizon.
VOTE ON FORWARD GUIDANCE LIKELY UNANIMOUS
News at the tail end of last week indicated the MPC voted on the forward guidance plan – as it does the asset purchase programme and Bank Rate. The minutes will likely show that the MPC was unanimous in its support for the plan announced by Carney. But expect some volatility if anything but a unanimous decision is announced Wednesday morning.
Most analysts are predicting universal agreement. Carney probably brought all members onside by setting out three “knock-out” conditions, wrote economists at Nomura. “Any concerns that certain members may have were probably accommodated by the considerable flexibility afforded through the knock-out clauses,” the economists said.
Phillip Shaw, economist at Investec, agrees, adding that “the get out clauses look to have had the effect of watering down the impact of the guidance itself.” Shaw elaborates that the raft of “knock-outs” implied less-than-convincing forward guidance to financial markets – a price Carney had to pay to get the MPC to fully back the new policy, he said.
Other analysts ponder whether the unemployment threshold of 7% was set at this relatively high level in order to charm some of the more stubborn members of the Committee into joining the pro-guidance gang. Martin Beck at Capital Economics highlights the necessity to do so – the credibility of the announcement hinged on the perception of a united MPC.
NO VOTES FOR QE PROBABLE
HSBC economists write, “given that the inflation report suggested that QE may still be a viable policy tool, it will be interesting to see if any members voted for additional asset purchases, although we suspect not.” The bank’s economists also believe “the vote on the final design to have been unanimous.”
Citi sees no votes for immediate QE this time around, but suspects “the MPC probably would resume QE to reinforce the ‘low for longer’ message of guidance” if the MPC found that an open mouth policy was not enough. Citi expects “overwhelming” support for the forward guidance framework among MPC members.
JOBS RECOVERY MARCHES ON
The ILO unemployment rate is also due to be released Wednesday morning, which now takes on special significance given the BoE’s new guidance. In the coming months, many analysts expect to see further falls in unemployment and the jobs recovery march on. But did we see significant improvements in the UK labour market in June?
The consensus estimate shows unemployment is expected to remain unchanged at 7.8% – still some way off the 7% threshold that will cause the MPC to reconsider its pledge to keep rates at the record low levels.
Investec expects to see the ILO measure hold steady at 7.8%, but note “that with even a modestly bigger drop than we are predicting, the rate would likely tick-down to 7.7%.” A more optimistic HSBC predict “the headline rate of unemployment will fall to 7.7% in July.”
It would appear that the risk is skewed to the downside.
MARKET PRICING IN RATE RISE BEFORE MID-2016
Overnight index swaps are currently pricing in a rate hike before the Bank forecasts unemployment will reach 7%. In fact, the market is pricing in a 25bp rise closer to 2015. In part this is explained by a more bullish view on the UK economy that has some betting on unemployment falling faster than the Bank’s three-year horizon.
“The threshold target for unemployment was higher than the market was expecting and the market’s perception was that if the economy recovers then rates might rise sooner,” said Paul Robson, currency strategist at RBS.
He added that the pound could now start to rise strongly in response to strong UK economic data, especially jobs data. “Sterling will now become more sensitive to activity data than simply to inflation data, as it was in the past,” commented Robson.
INFLATION PEAKS BUT WON’T RETURN TO TARGET SOON
Data released Tuesday supported the claim that inflation is likely to have peaked and will probably continue to ease. The rate of consumer prices index (CPI) inflation fell to 2.8% in July, down from 2.9% in June, according to the Office for National Statistics.
Inflationary pressures were expected to have eased in July, and not many economists see any upside pressures in the pipeline. The tick down in CPI perhaps allayed any fears that higher levels of inflation could become an obstacle to the durability of the Bank’s forward guidance (due to the two inflation-related “knock-outs”). Nevertheless, inflation is likely to remain above the 2% target for some time.
Nida Ali, economic adviser to the EY ITEM Club, forecasts inflation at around 2.2% in 2014 and 2015 – “still some way below the Bank of England’s 2.5% inflation knockout so the Bank can focus on getting unemployment down below 7% and keep rates at 0.5% until at least 2016.”
Written by Hannah Wood of Livesquawk