As expected, the Bank of England left interest rates unchanged this month but gave some subtle indications that an August hike might be on the way. If they do raise rates it will again be in line with the bank publishing a new inflation report and governor Mark Carney addressing the media (a trend picked up on many months ago through this blog).
Two things in particular stood out from the minutes of last week’s meeting. Firstly, the bank expects inflation to rise again over the coming months from its current level of 2.4%. As well as citing a rise in sterling oil futures, a leading cause by their own admission will be the renewed depreciation of sterling that began in April. To quickly summarise, the pound reached a post Brexit referendum high two months ago of $1.437, but began its descent days later when Mark Carney talked down the prospect of an interest rate hike in May. Sterling is now valued at $1.326, a 7.7% decline on the high set on the 17th of April.
It is now well documented that the BOE considered the pound’s drop immediately following the 2016 referendum as the cause for rising inflation. The rate hike administered in November last year (the first in ten years) was predicated largely on inflation running over the bank’s 2% target.
What we are seeing now is a similar scenario. A sustained fall in the value of sterling, which has dragged on for over two months, is now being presented as the reason for a expected rise in inflation over the summer. As a result of this the bank’s stance on raising interest rates in the near term has once again become more open.
The 2% inflation mandate that the bank reneged on between 2010 and 2013 has become relevant again. Judging by the BOE’s behaviour, they are being careful not to be seen as the saboteurs of the economy. When they cited worse then expected data as the reason for holding off on a May rate hike, inflation had started to fall back from the 3% level that triggered the rise in 2017. Now that they expect inflation to rise, they have a more solid basis with markets in which to carry on raising rates. To quote the bank directly, so as to ‘return inflation sustainability to its target.’
After last week’s MPC meeting, Stephen Gallo, who is head of European FX strategy at BMO Capital Markets, said that ‘the MPC has little reason to encourage a further extension of GBP weakness‘. Here, Gallo has failed to recognise that weakness in the pound is providing the bank with the reasoning required to further tighten monetary policy. And seen as that weakness is perceived as a symptom of Brexit, the BOE are successfully managing to avoid large scale public scrutiny for their actions.
The second significant part of the bank’s meeting was the revelation that they are now actively discussing the reduction of government and corporate bonds purchased in the aftermath of the ‘great financial crisis‘ of 2008. It was in July 2017 that MPC member Ian McCafferty said that the Bank of England should consider unwinding its balance sheet. Under previous guidance, the bank had set a threshold of 2% on interest rates to begin rolling off assets. That threshold has now been lowered to 1.5%.
The minutes indicate that the BOE will ‘seek to learn from the experience of other central banks‘. By other banks they mean The Federal Reserve, who began rolling off both treasuries and mortgage backed securities from its balance sheet last year. The BOE now looks set to follow in the wake of their American counterparts, further emboldening the narrative of the removal of monetary stimulus from financial markets being a global phenomenen.
In line with their policy on interest rates, the BOE intend to move gradually on reducing the stock of its balance sheet. However, the bank have given no assurances that this will prove the case:
In the event that potential movements in Bank Rate were judged insufficient to achieve the inflation target, the reduction in the stock of assets could be amended or reversed.
The important word here is ‘amended‘, which in plain English means increased. Interest rates only have to move another 1% for the roll off of assets to begin. At present, this is considered highly unlikely to happen anytime soon. Economists expect the bank to raise rates another three times over the next three years and for inflation to stabilize around the 2% level. What these same people often fail to identify is that the BOE’s inflation target works both ways.
As I have discussed previously, Mark Carney stated last year that in the event of a ‘bad‘ Brexit and a weakening economy, the BOE may not be in a position to provide stimulus. If the global trend on current monetary policy holds up (all signs are that it will), then the bank will do the opposite. A ‘bad‘ Brexit will inevitably weaken the pound and eventually work through to inflation. Under those circumstances, interest rates would rise faster than anyone is currently anticipating, meaning the timing of asset reductions would likely be brought forward. Especially if raising rates alone proves ‘insufficient to achieve the inflation target.’
- The Bank of England bolstered expectations that it will raise rates for only the second time since the financial crisis at its next meeting in August, after its chief economist (Andy Haldane) unexpectedly joined the minority of policymakers calling for a hike.
- The central bank also set out new guidance on when it might start to sell its 435 billion pounds ($574 billion) of British government bonds, saying this could come once rates have reached around 1.5 percent, sooner than previous 2 percent guidance.
- The government’s Brexit bill has passed through Parliament after Theresa May saw off a revolt by Tory MPs.
- Peers accepted the amendment to the EU (Withdrawal) Bill sent to them from the House of Commons, meaning the bill now goes for Royal Assent, becoming law.
- Economic gains are negating the need for crisis-era monetary policy, the Fed leader told a European Central Bank forum.
- “Earlier in the expansion, as the economy recovered, the need for highly accommodative monetary policy was clear,” Powell said, according to prepared remarks. “But with unemployment low and expected to decline further, inflation close to our objective, and the risks to the outlook roughly balanced, the case for continued gradual increases in the federal funds rate is strong.”
- While he said there remains uncertainty around monetary policy, the case for interest rate hikes is solid, a position he said is supported “broadly” by FOMC members.
- In a speech at France’s central bank, Weidmann said he believed euro zone inflation was finally getting to the European Central Bank’s target of close to but less than two percent.
- “Hence, ending the net purchases is most likely just the first step on a multi-year path of a gradual monetary policy normalization. And that’s precisely why it has been so important to actually get the ball rolling,” Weidmann said.
- French central bank head Francois Villeroy de Galhau earlier said that the ECB was confident inflation is on the right track, although the specter of protectionism and other risks including Brexit are adding to broader economic uncertainty.
- One of the most glaring declines has come from Russia, which sliced its holdings of U.S. debt nearly in half from March to April, from $96.1 billion to $48.7 billion. Russia’s Treasury ownership peaked at $108.7 billion in May 2017.
- China, the largest owner of U.S. debt, reduced its level by $5.8 billion in April to $1.18 trillion, while Japan, the second largest, cut its holdings by $12.3 billion to $1.03 trillion. Ireland, the U.K. and Switzerland also pulled back.
- Finding buyers for government debt has become increasingly important since the Federal Reserve halted its bond-buying program in October 2016 after swelling its holdings to more than $4.2 trillion.
- The ongoing tensions over international trade are the biggest economic risk to the euro zone, the managing director of the International Monetary Fund said Thursday.
- Lagarde added that “retaliation, escalation, if that happens because then you’re talking about higher macroeconomic impacts and, second, the undermining of confidence that has presided over the relationship of partners under the rules-based system.”
- US President Donald Trump has threatened to impose tariffs on an additional $200bn (£151bn) of Chinese goods in a growing trade row.
- Mr Trump said the 10% tariffs would come into effect if China “refuses to change its practices”.
- The threats would be a major escalation of the dispute and sparked further falls on stock markets.
- “I am a little concerned that trade policy could evolve in a way that leads to higher trade barriers, and immigration policy could evolve in a way that leads to much less immigration in the U.S. and therefore less productive capacity for the economy,” New York Fed President William Dudley told reporters on his last day on the job.
- House of Fraser has been given approval by creditors to close 31 of its 59 stores, resulting in up to 6,000 job losses.
- The shops earmarked for closure, including its flagship Oxford Street store in London, will remain open until early 2019.
- Debit card payments have overtaken cash use for the first time, new figures show, as contactless technology takes a firm hold on day-to-day spending.
- A total of 13.2 billion debit card payments were made last year, a rise of 14% on the previous year, according to banking trade body UK Finance.
- That outstripped the 13.1 billion cash payments made, as the use of notes and coins dropped by 15%.
- An estimated 3.4 million people hardly used cash at all during the year.
- The head of Nato has warned that the deep divisions between the US under Donald Trump and its European allies are not going away and there is no certainty that the transatlantic relationship and its military alliance will survive.
- Writing in the Guardian, Nato’s secretary general admits that “political storm clouds” are putting a strain on the ties that bind the Nato allies.
- Debenhams said full-year profits will be lower than expected – the third time it has issued a profit warning this year.
- The department store blamed “increased competitor discounting and weakness in key markets” for the profit shortfall.
- It said annual pre-tax profits would come in between £35m and £40m, below previous estimates of £50.3m.