Carney Guidance Risks Being Drowned Out by Recovery: U.K. Credit
Mark Carney’s plan to guide investors on the future cost of borrowing risks being drowned out by Britain’s strengthening economic recovery.
The Bank of England governor will present a review tomorrow on implementing forward guidance in the U.K. as improving economic data boosts the future cost of money. He has already taken steps to curb higher borrowing costs, saying last month that the “implied rise in the expected future path of bank rate was not warranted” by economic developments.
Carney faces a struggle to keep investors’ expectations in check after indexes of services, manufacturing and construction exceeded economists’ forecasts last month, pushing two-year gilt yields to the highest in two weeks relative to equivalent German notes. Deutsche Bank AG said the data are now at a level where the BOE has previously tightened policy.
“He’s going to have to shout very loudly,” Philip Rush, an economist at Nomura International Plc in London, said in a telephone interview yesterday. “But the idea we’re getting strong data now really just confirms why you need to have some form of forward guidance at the moment.”
In addition to the industry surveys, a revival in the housing market and improving consumer confidence are providing signs of a U.K. recovery after economic growth accelerated to 0.6 percent in the second quarter.
The forward rates for Sterling Overnight Index Average swaps rose as the outlook brightened. The rate at which banks expect to charge each other by the BOE’s August 2014 policy meeting climbed to 0.403 percent yesterday, the most since July 3. That’s up from 0.352 percent a week ago.
The BOE’s Monetary Policy Committee kept its target for bond purchases at 375 billion pounds ($575 billion) last week and left its key rate at 0.5 percent, a record low.
Carney will publish the quarterly Inflation Report at a press conference in London at 10:30 a.m. tomorrow, his first since becoming BOE governor. Alongside the new forecasts, he will release a review of forward guidance requested by the government and a view of the trade-off between growth and inflation.
“The problem is that the economy is improving,” said Steve Barrow, head of Group-of-10 research at Standard Bank Plc in London. “For all the bank might end up doing is fighting the market, not guiding it.”
Comments by European Central Bank President Mario Draghi last week suggest Carney may need to be more specific in his guidance. Draghi echoed the BOE governor when he said on Aug. 1 that expectations of a rate increase in the euro area are “unwarranted.” He also reiterated last month’s guidance that all key ECB rates will stay at current levels or lower for an “extended period of time,” without specifying that period.
A measure of expected overnight interbank borrowing costs rose after Draghi’s remarks. The rate banks expect to charge each other by the ECB’s July 2014 policy meeting climbed as high as 0.25 percent, the most since July 26. That’s up from 0.19 percent immediately before Draghi spoke.
Austin Hughes, chief economist at KBC Bank Ireland in Dublin, said the ECB’s guidance is a “work in progress.”
“The entire range of implications of this course of action may not have been completely thought through,” Hughes said.
Carney introduced guidance in April 2009 while governor of the Bank of Canada -- pledging to keep Canada’s key rate at a record low until mid-2010.
He will align BOE policy closer to the Federal Reserve’s by linking guidance on interest rates to economic developments, according to a Bloomberg News survey of 43 economists published last month. In the poll, 23 said the governor will opt to link a pledge on loose policy to economic data, while 18 said he will use a period of time.
The Fed said on June 19 that keeping its key rate between zero and 0.25 percent “will be appropriate at least as long” as unemployment remains above 6.5 percent and the forecast for inflation in one to two years doesn’t exceed 2.5 percent. The same day, Chairman Ben S. Bernanke said officials may slow its monthly bond buying later this year.
The comments sparked a jump in bond yields, prompting the MPC to say on July 4 that the increase represented an “unwelcome tightening in monetary conditions” that could scupper the recovery.
The pound strengthened against the dollar after a report yesterday showed services expanded at the fastest pace in six years in July. It advanced 0.3 percent to $1.5338 as of 6 p.m. London time. Ten-year gilt yields rose, widening the premium over similar-maturity German debt to 78.8 basis points, the most in more than three years. The two-year yield reached 0.38 percent, the highest since July 8. The spread over German notes widened to 21.5 basis points, the most since July 22.
While Britain’s economy is strengthening, the recovery may not yet be assured. Kevin Daly, chief U.K. economist at Goldman Sachs Group Inc., says that reinforces the need for continued loose policy.
U.K. gross domestic product in the second quarter was still 3.3 percent below its peak in early 2008. The National Institute of Economic and Social Research said last week that the outlook is for a “gradual gain” in economic momentum even as it raised its forecasts.
“They’ll want to maintain an accommodative stance for some time,” Goldman’s Daly said in an interview in London. “Growth is getting better, but it needs to be better for a long time given how long it was weak. You don’t want the recovery to be choked off by a premature tightening of financial conditions.”
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