Carney BOE Rates Guidance Meets Investor Skepticism: U.K. Credit
Gilt yields rose to the highest in more than a month yesterday after Carney took the unprecedented step of saying the bank probably won’t raise its benchmark rate from a record low 0.5 percent until unemployment falls to 7 percent. While policy makers don’t expect that to occur before the third quarter of 2016, investors bet faster inflation will force them to act sooner.
“Markets have taken the view that the inflation conditionality that can suspend the bank’s forward guidance dilutes the effectiveness of the pre-commitment to keeping rates low for longer,” said Lena Komileva, chief economist at G+ Economics in London.
The reaction highlights the challenge Carney faces in introducing Federal Reserve-style policy thresholds as the U.K. economy strengthens and makes him the latest central banker at odds with financial markets. Economists from Nomura International Plc to Deutsche Bank AG are among those to forecast interest rates will be increased in 2015.
The pound rose as much as 1.2 percent to $1.5531 yesterday, the highest in almost seven weeks, and it was trading at $1.5505 as of 10:05 a.m. in London today. The yield on the 10-year gilt, which yesterday increased to 2.56 percent, the most since June 25, was little changed at 2.47 percent. That’s 80 basis points more than the yield on equivalent German debt, the widest spread since June 2010. Three-month short sterling futures maturing in September 2016 were down 5 basis points at 1.85 percent after gaining 6 basis points yesterday.
Asked on Sky News television about the market reaction to the guidance, Carney said the moves were “very marginal.”
Investors were responding to an overhaul of communications at the BOE just over a month since Carney, the former Bank of Canada governor, took the reins pledging to be innovative in acting to speed up the weakest U.K. recovery on record.
Carney’s aim is to reduce uncertainty about the policy path as the economy gathers pace, supporting the revival by persuading investors to reverse recent gains in market rates he calls “unwarranted” and encouraging consumers and companies to spend.
Under a plan that echoes one introduced by the Fed in December, the BOE said joblessness must fall to 7 percent from 7.8 percent for a rate increase to be considered. It forecast that’s unlikely to happen for three years and will require the addition of 750,000 new jobs.
The Monetary Policy Committee’s commitment is voided if policy makers decide medium-term inflation is likely to breach 2.5 percent, price expectations are no longer well-anchored or if financial stability is viewed as being at risk.
It was those “knockouts” that investors focused on as they questioned the strength of commitment by suggesting inflation concerns may prove too much for the bank to bear. The BOE currently predicts consumer-price growth will slow to its 2 percent target in the fourth quarter of 2015 from 2.9 percent in June. It has been above the goal since 2009. Speaking on BBC Radio 4 today, Carney said inflation remains the BOE target “without question.”
The MPC has “gone out of its way to avoid having its hands tied,” said Victoria Clarke, an economist at Investec Securities in London. “These clauses look to have been unhelpful for the credibility of the new guidance.”
Clarke added that, given signs of a faster economic recovery, unemployment could drop below 7 percent as soon as the end of 2015. Indexes of services, manufacturing and construction all exceeded economists’ forecasts last month, signaling continued momentum in the economy after 0.6 percent growth in the second quarter.
Jens Larsen, chief European economist at RBC Capital Markets in London, revised his forecast to show the BOE raising its key rate in the third quarter of 2016, a year later than he previously expected. Citigroup Inc. economist Michael Saunders said the central bank won’t hike before 2017.
Deutsche Bank’s George Buckley said the curbs on the thresholds may not prove binding, noting the bank has never forecast inflation above 2.5 percent in two years’ time even when it breached 5 percent. The two other controls are open to wide interpretation and judgment calls, he said.
Still, he refused to adjust his forecast to fully reflect Carney’s direction that policy will remain on hold for another three years, pushing back his call to 2015 from 2014.
“The bank may feel very different about the need to tighten policy in the future,” he said. “While we need to put back our forecast for the rise in interest rates on account of today’s message from the bank, we do not see it being as late as 2016-2017.”
The choice of unemployment as a metric revived a debate among economists as to whether it is a good proxy of economic health in the U.K., given that it has fallen from a crisis high of 8.4 percent in 2011 even as the economic recovery has proved sluggish. That drop has prompted suggestions U.K. productivity is lackluster and the economy more inflation-prone than previously.
“The BOE can say it doesn’t expect to hit 7 percent for such a long time, but its record on forecasting such things is easily bad enough to lack credibility,” said Philip Rush, an economist at Nomura in London. “Our forecast is for unemployment to fall much faster and thus rate hikes to come earlier.”
Data also might fail to show whether workers have been forced to accept part-time jobs and, as in the U.S., joblessness might drop because people are leaving the workforce, said Clarke at Investec.
Another concern is whether the crisis has left a large proportion of U.K. workers unemployable, which would mean the labor market is already tight, according to Marc Ostwald, a strategist at Monument Securities.
Carney defended the use of joblessness as a metric, calling it understood, widely available and not subject to revisions.
The Bank of England isn’t alone in revamping communications in a bid to boost growth at a time when interest rates are about rock-bottom and there are questions about the effectiveness of asset purchases.
Fed Chairman Ben S. Bernanke introduced unemployment and inflation parameters in December to guide rate increases, while Bank of Japan Governor Haruhiko Kuroda aims to deliver 2 percent inflation within two years. European Central Bank President Mario Draghi has pledged to keep his benchmark low for an “extended period.”
The challenge has been that markets aren’t fully buying those messages as the world economy improves and the Fed signals it may begin tapering its asset purchases as soon as next month. Bernanke has had to stress a slowing of stimulus doesn’t mean imminent rate increases, while investors have pushed up market borrowing costs in the euro area as it appears set to leave recession.
The next test for the BOE’s strategy is the Aug. 14 release of minutes for the meeting last week at which policy makers agreed to the new framework. Officials including Spencer Dale and Paul Fisher were among those to question the use of guidance prior to Carney’s arrival.
“It will now be vital for the markets to see if these decisions were unanimous,” said Nick Beecroft, chairman of Saxo Capital Markets U.K. Ltd. “Absence of unanimity will undermine the whole message and probably increase fears of earlier tightening.”
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