Feb. 21 (Bloomberg) -- Investors are making it easier for Bank of England Governor Mark Carney to keep interest rates at a record low.
Expectations that policy makers will raise borrowing costs next year have already led to an increase in market rates that could weigh on growth, according to Steven Major, global head of fixed-income research at HSBC Holdings Plc in London. The six-month sterling Libor rate is within two basis points of a 10-month high reached in December.
Carney is experiencing what his predecessor Mervyn King called the Maradona effect, a theory of monetary policy also deployed by the Federal Reserve and the European Central Bank. In 2005, King cited Argentinian soccer player Diego Maradona’s second goal against England in the 1986 World Cup to illustrate how central banks can let expectations they will act, rather than action itself, do the job for them. Maradona, King said, beat five English players by running in a straight line.
“Some market rates have already gone up in anticipation for stronger data and an increase in the benchmark rate,” Major said. “It may take some months before it affects the real economy, but we’ve seen in the past this could affect spending and hiring. It’s hard to see rates going up any time soon.”
Royal Bank of Scotland Group Plc, Nationwide Building Society and Banco Santander SA raised rates on five-year fixed-interest mortgages this month. Expectations of higher interest rates also boosted sterling, which has appreciated about 8 percent against a basket of nine developed-market peers since Carney took over the central bank in July.
That makes British exports less competitive and damps imported price pressures, reducing the need to increase borrowing costs. The five-year break-even rate, a market gauge of inflation expectations derived from the yield gap between nominal and index-linked bonds, fell to 2.68 percentage points on Feb. 12, the least since August. It was at 2.72 points as of 2:40 p.m. London time. Sterling gained 0.1 percent to $1.6671.
Goldman Sachs Group Inc. estimates financial conditions are at their tightest since mid-2012. Its daily index has risen 12 basis points this year and by 94 basis basis points since Carney became governor. A full-point increase tends to knock 1 percent off gross domestic product over two years, according to the investment bank.
‘Hand of God’
In Mexico City 28 years ago, Argentina beat England in the World Cup quarterfinals. Maradona scored the first goal in the 2-1 win via an unpenalized handball, which he described after the game as the “Hand of God.” Minutes later, he collected the ball in his own half and ran 60 meters before poking it past England goalkeeper Peter Shilton. It was voted World Cup Goal of the Century in a 2002 FIFA.Com survey of soccer fans.
“How can you beat five players by running in a straight line?” King said in his 2005 speech in London. “The answer is that the English defenders reacted to what they expected Maradona to do. Because they expected Maradona to move either left or right, he was able to go straight on.”
The theory, as it applies to monetary policy, has been used by the world’s major central banks in recent years.
ECB President Mario Draghi’s July 2012 pledge to do “whatever it takes” to preserve the euro sent borrowing costs for Italy and Spain tumbling from levels that had fueled concern the countries might be forced to seek sovereign bailouts. The bank’s unlimited bond-buying program remains untapped.
In the U.S., monetary conditions tightened in the past nine months as the Federal Reserve prepared to reduce stimulus. With no change in the key policy rate, mortgage rates have risen by 100 basis points, while inflation expectations dropped, according to Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co.
“Economies slow when that happens,” Gross said via Twitter this week.
Carney has used forward guidance in an attempt to assure borrowers, with officials pledging last week not to increase the 0.5 percent benchmark rate until the economy has used up more of its spare capacity. Policy maker Martin Weale told Sky News yesterday the next rate increase is most likely to happen in the spring of next year, a view in line with economists in a Bloomberg survey.
The spread between the rate to exchange floating for fixed payments over the next five years and yields on similar-maturity gilts swelled to almost 34 basis points this week, the most in 1 1/2 years, as traders boosted bets rates will rise. The so-called swap spread, a gauge of bank funding costs, has tripled since June. It was 33 basis points today.
Nationwide Building Society raised its five-year mortgage rate with a 60 percent loan-to-value ratio on Feb. 19, to 3.09 percent from 2.99 percent. RBS increased the cost of a similar loan to 2.95 percent from 2.88 percent earlier this month.
“Longer-term fixed rates have gone up a bit recently and that partly reflects market expectations of where interest rates will be,” said Wesley Davidson, a director at mortgage broker Fox Davidson in Bristol. “We are not saying ‘jump into the boat now or you will miss it,’ because mortgage rates overall remain at multi-year lows. But some are starting to rise.”
After its strongest expansion since 2007 last year, the U.K. economy is showing signs of cooling. Retail sales dropped 1.5 percent in January, the most in almost two years, a government report showed today. Evidence yesterday of a slowdown in the euro area, which buys almost half of British exports, highlighted the risks to a recovery that Chancellor of the Exchequer George Osborne warned this week is not yet secure.
“The market should take what Carney said at face value,” said John Stopford, head of fixed income at Investec Asset Management in London. “Some tightening potentially is already taking place. There is still a fair amount of spare capacity in the economy and inflation is subdued. At this point I still think it’s unlikely the central bank will increase interest rates as early as what’s currently being priced in by the market.”
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