Yellen Caution Sends Signal to Carney That BOE Should Stay Wary

  • Fed left U.S. rate unchanged, citing international risks
  • BOE's Haldane says next U.K. policy move may even be loosening

The Federal Reserve’s assessment of rising international risks and a weak outlook for inflation probably looks familiar to Mark Carney.

As Fed Chair Janet Yellen cited “heightened uncertainties abroad” and a “slightly softer” inflation path as reasons for keeping interest rates unchanged on Thursday, the Bank of England governor could have been forgiven for thinking she was describing his own predicament. The Fed statement underscored the lack of clarity about how global events such as the slowdown in China will affect domestic growth, echoing the balancing act faced by U.K. officials.

While both central banks are getting close to withdrawing their unprecedented stimulus, Yellen’s press conference may have given clues as to whether the BOE’s Monetary Policy Committee will delay its own tightening plan. Increased international links mean that in the past 20 years the BOE has tended to follow its U.S. counterpart with a lag of about three months, according to economists at Deutsche Bank AG.

“The basic logic is, if the Fed is worried about global risks, then the U.K. is certainly more vulnerable to any global risks than the U.S. is,” Adam Posen, president of the Peterson Institute for International Economics in Washington and a former BOE policy maker, said in an interview in London on Thursday after the Fed decision. “That should be a warning shot. It’s very hard to understand why the Bank of England wouldn’t see any of the same risks.”

Market Measure

Forward contracts based on the sterling overnight index average, or Sonia, suggested that a full 25 basis-point increase in the BOE’s key rate won’t come until November 2016, compared with August before the Fed decision.

Bank of England Chief Economist Andy Haldane said in a speech on Friday that the risks to U.K. growth and inflation are "skewed squarely and significantly to the downside." The sharp appreciation in sterling and subdued world growth have such potentially deflationary effects that the next move in monetary policy may need to be loosening rather than tightening, he said.

U.K. government bonds surged on Friday, with the 10-year yield falling 10 basis points to 1.85 percent. The pound weakened 0.7 percent to 73.35 pence per euro on Thursday and was 0.4 percent stronger at 73.08 pence as of 12:56 p.m. in London on Friday. Against the U.S. currency, it added 0.3 percent to $1.5636 after climbing 0.6 percent on Thursday.

In the U.K., as in the U.S., rate-setters must weigh an inflation rate that’s too low against solid labor-market data. Slowing growth in China, the world’s second-biggest economy, has rippled across the world, sparking financial turmoil and a slump in global commodities that may exacerbate downward price pressures.

The U.S. PCE index has run below the Fed’s 2 percent target for more than three years, even with the jobless rate falling to a seven-year low of 5.1 percent. Officials said Thursday that they don’t expect to attain their goal until 2018. In the U.K., where unemployment slid to 5.5 percent in the three months through July to match the lowest level since 2008, consumer-price inflation is zero.

‘Sharper Relief’

“With increased globalization, it means the conditions facing the U.S. economy are likely to be similar to the ones facing the U.K.,” said George Buckley, an economist at Deutsche Bank in London. “So if the BOE were to follow the Fed, they would not be blindly following, it would be because the U.K. is experiencing similar conditions to the U.S.”

At the European Central Bank, President Mario Draghi has the opposite conundrum to the Fed and BOE, and may now have to consider easing policy even further. The euro area is partly looking toward lower rates compared with its peers to help maximize the impact of its own stimulus.

“Presumably the euro won’t depreciate against the dollar as quickly as generally expected, so the exchange rate will provide less of a tailwind to the euro-area economy than the ECB would have hoped for,” said Marchel Alexandrovich, an economist at Jefferies International Ltd. in London. “The ECB will have mixed feelings about the decision.”

‘Daft Idea’

The BOE will increase its key rate from 0.5 percent in May 2016, Buckley forecast. Yellen said most Fed officials still expect a rise in U.S. interest rates this year. Federal funds futures are now showing a less than 50 percent chance that the central bank will raise rates in 2015.

Carney said on Wednesday that the BOE’s decision is likely to be clearer around the turn of the year. If economic expansion is above trend, labor costs and wage growth continue to rise and core inflation accelerates, “then the decision comes into much sharper relief and it may be appropriate to begin withdraw stimulus at that point,” he said.

David Miles-- whose term on the MPC ended last month -- refuted the idea that the BOE has to wait until the Fed increases rates to do so itself. In a speech in July, he said it’s a “daft idea that we cannot raise rates in the U.K. before the U.S. and also cannot be long behind them.”

Even so, Posen said such a move would probably cause the pound to appreciate against the dollar.

“The bank would be reticent about going before the Fed,” said Rob Wood, an economist at Bank of America Merrill Lynch and a former BOE official. “They’re at a similar stage of the recovery. They’re talking about rate hikes. If that’s going to be delayed for considerably longer then there’s probably been a really big event that is going to impact them both.”

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