UK reaction: Carney comments suggest a more cautious BoE
David Page, Senior Economist at AXA Investment Managers (AXA IM) comments on today’s statement from the Bank of England’s Governor.
- Governor Carney discussed “mixed” data and “other [MPC] meetings over the course of the year” in an interview yesterday.
- The statement appeared aimed at overwhelming market expectations for a May rate hike.
- With our own view affected by previous BoE guidance, we take the Governor’s comments to introduce caution over the outlook.
- May’s BoE meeting (10 May) looks set to be a close call. On balance, we revert to our original expectation of a more cautious hike in August.
- We shift our interest rate view to August this year and consider the next hike likely only in 2019.
- We forecast two hikes in 2019 and pencil in a further two hikes in 2020, but echo Governor Carney that such an outlook will be governed by longer term Brexit decisions.
BoE Governor Mark Carney gave an interview to the BBC yesterday. He stated that the “big picture” is that people should “prepare for a few hikes over the next few years”, subject to future decisions over Brexit that presented the largest unknowns to the economy. On the near term outlook, he said he did not want to be “too focused on precise timing”, but that recent data had been “mixed”, that the MPC would consider all of this “in the round” in its May meeting, but that while the Committee would likely exhibit a range of views it would be “conscious that there are other meetings over the course of the year”. This comment appeared a deliberate pushback at the expectation that the MPC would tighten monetary policy in May. The Governor likely felt compelled to make such an intervention as markets and commentators alike have recently been focused on perceived BoE guidance, over and above underlying data.
After the BoE’s forceful intervention in markets last September to warn of a rate hike “in the coming months”, the Bank suggested an outlook of “a couple” of hikes over the next few years. We disagreed, pencilling in one rate hike in August 2018 and two in each of the subsequent years. In February, the Bank described policy tightening as likely “somewhat sooner and to a somewhat greater degree” than previously suggested. Markets adjusted their expectations for a May rate hike on this outlook. Although we resisted this move initially, minutes from March’s meeting (four weeks ago), suggested the Bank was offering no correction to this market move and, as such, we shifted our expectation for the next hike to May from August. However, we have maintained that our outlook was based on our interpretation of BoE guidance, not an economy that suggested an urgency for tighter policy.
Recent data has provided mixed arguments for the outlook. We break these down into arguments for a hike, against a hike and ‘noise’ for the monetary policy debate.
- For. The labour market is broadly tightening in line with BoE expectation. If anything unemployment might be falling at a modestly faster pace than expected in February, although earnings growth does not appear any faster. The outlook for the labour market and the materialisation of BoE wage growth expectations is the main driver of the MPC’s medium-term outlook for tighter policy.
- Against. Inflation has fallen quicker than we and the MPC expected. Q1 recorded inflation at 2.7%, compared with February BoE forecasts of 2.9%. Our forecast is now for CPI to fall to 2.3% in Q2 compared with a BoE forecast of 2.7%. Some of this softness is likely to be noise (associated with high street weakness). Some could reflect a weaker underlying inflation backdrop than the BoE expected in February. If this proves persistent, the MPC may not need to tighten as much over the coming years as it currently projects. That outlook is uncertain for now, but it argues caution at tightening policy too soon. Moreover, the recent 1.5% rise in trade-weighted sterling should also soften the medium-term inflation outlook. Sterling’s gains are likely only in part the result of interest rate expectations (that might recede), with continued Brexit negotiations helping sterling higher.
- Noise. Much has been made of the dip in construction and services PMIs and March’s weak retail sales. This will likely culminate in a weak Q1 GDP growth estimate next week. The BoE has lowered its forecast to 0.3% from 0.4%, consistent with our own outlook, although we see risks skewed to a weaker 0.2%. We see most of this softness as weather related and temporary. We expect GDP growth to rebound in Q2 to 0.5% and still pencil in growth of 1.7% for the year as whole. Insofar as the BoE also regards recent weaker activity as weather related –a speech today by BoE member Saunders makes this case, referring to “unusually heavy snow” – it should look through this growth volatility. However, there are always risks that softness disguises a weakening trend, which some may consider adding to the case to wait. Growth concerns may be exacerbated by weaker outturns in US and Eurozone activity than considered in February.
To be clear, we still concur with the broad outlook for tighter monetary policy. As we stated in March “We expect GDP growth of 1.7% this year and 1.8% next (ahead of the 1.5% consensus). We believe this is faster than UK potential GDP growth, that it would drive labour market slack lower and generate domestic inflationary pressure. We forecast five hikes over the coming three years, broadly consistent with the BoE’s February projections which were conditioned on three hikes over the coming three years and left a modest overshoot of the inflation target at the two-year horizon (equivalent to a further hike).” This broad macro view for a gradual and modest tightening in monetary policy over the coming years is consistent with the MPC’s long-standing outlook, and Governor Carney and MPC member Saunder’s recent statements, describing a likely gradual pace of tightening. Such a gradual pace suggests no urgency, but needs to continue at some point.
So would the BoE resume tightening policy in May or August? Mixed evidence is likely to make this meeting a close call. Our recent shift from a cautious August expectation was based on BoE communication that we thought was eschewing such an approach. Carney’s comments cast doubt on any clear communication from the BoE. Accordingly we, return to considering a cautious outlook as prevailing and shift our next hike expectation back to August. Pushing our rate view back three months, we no longer consider a November follow up (now just three months) as likely. We push this back to 2019, considering May as more likely than February (given the uncertainty of data around this time of the year and it preceding the UK leaving the EU). We forecast two hikes in 2019 and still see rates closing 2020 at 1.75% - albeit as Governor Carney repeats this will be dependent on subsequent Brexit decisions. Our outlook still stands modestly in excess of current market pricing.
Financial markets have drawn to similar conclusions and markets have reacted sharply to the Governor’s comments. The implied probability of a May hike (from OIS markets) has collapsed to 55% from over 80% yesterday. Markets consider a 70% chance of a hike in August. 2-year and 10-year yields fell by 3bps and 5bps to 0.85% and 1.49% respectively (a fall cushioned by this being a shift in the perceived timing of rate hikes, not the extent). Sterling fell by 0.9% to the US dollar and 0.5% to the euro, a dip that helped UK equities rise by 0.5% on the day.
All data sourced by AXA IM as at 20 April 2018
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