Amidst increasing geopolitical tensions, the Bank of England and the Federal Reserve continue to push the narrative of more interest rate rises in the coming months.
Ian McCafferty, a member of the BOE’s Monetary Policy Committee and an outspoken critic of loose monetary policy, warned this week that the bank ‘should not dally when it comes to tightening policy modestly.’ He also said that potential problems with the Brexit process would be a ‘permanent feature of the landscape.’
It was in October 2017 that McCafferty stated how financial markets had wrongly assumed that Brexit uncertainty would prevent the bank from raising rates.
For the record, McCafferty is known as one of the most ‘hawkish‘ members of the MPC committee, having last year called for the BOE to begin considering the wind down of its quantitative easing programme.
Meanwhile, minutes from the Federal Reserve’s FOMC meeting in March showed that many members now see steeper rate hikes as being necessary. This is largely based on the expectation that inflation will reach the bank’s 2% target and remain there. Members also discussed adapting the Fed’s official monetary policy position from ‘accommodative‘ to ‘neutral or restraining‘. Once again, there is nothing in their language to suggest that volatility in equity markets will curtail their plans to further increase rates and roll off assets from their balance sheet.
Back in the UK, The Royal Institution of Chartered Surveyors has warned that a reduction in housing market activity could be reason enough for the Bank of England to not raise rates in May. Even though buyer demand has fallen for a consecutive twelve months, I believe the notion that the BOE will delay a rate hike next month is a fatuous argument. When the bank raised rates in November last year, they did so to the backdrop of falling GDP, stagnant wage growth, Brexit uncertainty, record levels of consumer debt, falling retail sales volume, falling consumer spending, a contracting construction industry and slowing service sector growth.
There’s been little to no improvement in financial conditions since then. For instance, GDP is estimated to have fallen for the first quarter whilst construction continues to be mired in recessionary conditions. The housing sector has not been a feature in recent MPC meetings. The BOE have been actively ignoring stress points in the UK economy and have instead been focusing solely on inflation and a reduction in slack due to supposed record levels of employment. I strongly suspect this will continue to be the case come May.
There remains the perception, however, that central banks will ultimately come to the rescue of markets if a sustained downturn originates. Zero Hedge ran a story this week about how the European Central Bank and the Fed have raised concerns about the probable impact of protectionist measures on trade. Not only did the site interpret the ECB’s comments as ‘dovish‘, they stated that:
The more aggressive Trump is with China on trade, the fewer rate hikes and less tightening to come.
Zero Hedge are not alone in thinking banks will relent on rate hikes should the global economic climate become more volatile. One of the chief consequences of a prospective trade war will likely be heightened inflation. Whilst the Fed and the Bank of England have in the past reneged on their 2% inflation target in favour of keeping rates low, they are now communicating the opposite. The international trend has been towards monetary tightening ever since the advent of Donald Trump’s election victory.
As discussed in previous posts, BOE governor Mark Carney said last year that in the event of a ‘bad‘ Brexit deal, the bank would be unable to respond by cutting rates due to the inflationary pressure such a deal would cause.
If a trade war results in rising global inflation, the evidence at hand suggests that the Fed and their counterparts will respond by further tightening policy rather than propping up markets.
- “That system of rules and shared responsibility is now in danger of being torn apart,” Lagarde said, referring to the multilateral trade order she said helped bring millions out of poverty. “This would be an inexcusable, collective policy failure.”
- “Governments need to steer clear of protectionism in all its forms,” Lagarde said. “History shows that import restrictions hurt everyone, especially poorer consumers.”
- Construction across the UK continues to fall, according to the latest research from the Office for National Statistics (ONS). The February ONS figures show that construction fell 1.6 per cent month-on-month, and was down three per cent compared to February last year.
- Meanwhile manufacturing fell 0.2 per cent in February, with the biggest decline seen in the manufacture of machinery.
- Carpetright says it is closing 92 stores and cutting 300 jobs as part of a restructuring plan.
- The chain is planning a company voluntary arrangement (CVA) that will allow it to shut the worst-performing stores and ask for rent concessions on another 113 sites.
- Online retailer Shop Direct will close three warehouses in Greater Manchester, putting nearly 2,000 jobs at risk.
- The group, which owns Very.co.uk and Littlewoods.com, said it would close its sites in Shaw, Little Hulton and Chadderton.
- It plans to build a new warehouse in the East Midlands employing 500 people, but said redundancies were likely.
- “A number of participants indicated that the stronger outlook for economic activity, along with their increased confidence that inflation would return to 2 per cent over the medium term, implied that the appropriate path for the federal funds rate over the next few years would likely be slightly steeper than they had previously expected,” the minutes said.
- Given the positive outlook, several participants in the meeting thought the Fed may ultimately need to set rates above the long-run normal value, arguing for new language acknowledging that the central bank may shift from accommodative settings to a neutral or “restraining” monetary policy stance.
- US inflation rose at the quickest pace in a year in March, providing the pick-up that the Federal Reserve has been predicting as policymakers continue to deliberate on the pace of interest rate rises this year.
- The core consumer price index, which excludes volatile food and energy prices, showed prices were 2.1 per cent higher last month compared to the same period last year. That’s up from the 1.8 per cent rate recorded in February and is the fastest pace since February of last year.
On today’s balance sheet, there are $2,413 billion in Treasuries, down $11 billion from February 28 ($2,424 billion). In total, since the beginning of the QE-Unwind, the balance of Treasuries has dropped by $53 billion, to hit the lowest level since July 16, 2014.
- Federal Reserve Bank of Dallas President Robert Kaplan said trade issues between the U.S. and China won’t get resolved soon and warned of potential damage if the dispute is prolonged.
- “I really do think it is too early to judge how this is going to affect the economy,” Kaplan said on Bloomberg Television from Beijing. “But I do think the rhetoric, if it goes on for long enough at this level, is having somewhat a chilling effect.”
- Powell, in his first speech on the economic outlook since assuming the helm at the U.S. central bank in early February, said the labor market appeared close to full employment and that inflation was poised to rise toward the Fed’s 2 percent objective in the coming months.
- “As long as the economy continues broadly on its current path, further gradual increases in the federal funds rate will best promote these goals,” Powell said at an event in Chicago.
- The Federal Reserve on Tuesday proposed new rules that could allow some large banks to reduce the amount of capital they must hold as a cushion against a future economic shock.
- The proposal may clear the way for some large banks to reduce their capital levels in the future but the largest firms on Wall Street are not likely to get such relief, the Fed said.
- The proposal is expected to reduce bank paperwork and also make it easier for regulators to monitor the health of banks, said Randal Quarles who is the top Fed official in charge of regulations.
- The International Monetary Fund has said advanced economies such as Britain, the US and Japan risk being overwhelmed by their ageing populations, and calls on them to throw open their borders to more migrant workers in response.
- Within the next few decades, working-age adults will need to support double the number of elderly people than they do now, putting immense pressure on welfare systems and wiping out as much as 3% of potential economic output by 2050, the IMF said in its latest World Economic Outlook report.