Carney’s Debut Speech Frees Gilt Yields to Climb
Investors who’ve driven 10-year gilt yields higher ever since Mark Carney joined the Bank of England now have the governor’s blessing.
In his first speech as head of the central bank, Carney told business leaders in Nottingham in the English midlands that “longer-term market interest rates are certainly relevant, but what matters most to you is actually what happens to bank rate, now and in the future.” He said that’s because rates on 70 percent of loans to households and more than 50 percent of loans to businesses are linked to the BOE benchmark.
“It gives the impression they don’t care about the longer end; that’s a green light for yields to rise and that’s playing with a bit of fire,” said David Tinsley, an economist at BNP Paribas SA in London and a former BOE official. “He seems much more focused on the short end and reaching out to businesses and households over and above the head of the markets.”
Carney introduced forward guidance on Aug. 7 and said the BOE plans to keep its benchmark at a record-low of 0.5 percent at least until unemployment falls to 7 percent, which it doesn’t see happening for another three years. Gilt yields have risen since that announcement and investors have increased bets on higher rates, suggesting they aren’t convinced.
The yield on the 2.25 percent gilt due in September 2023 rose 3 basis points to 2.80 percent yesterday and is up 25 basis points this month. Short-sterling futures fell, indicating investors are adding to bets on higher interest rates. The implied yield on the contract expiring in September 2015 increased 4 basis points to 1.32 percent.
For the BOE governor, investors may not be his target audience as he looks to boost spending and investing to add momentum to a recovery lagging most other developed economies. He said guidance “reaches directly to those who put capital to work, households and businesses.”
“The focus on forward guidance at this point appears to be to deliver a message directly to the man on the street rather than the markets that rates aren’t going to go up,” said Michael Amey, money manager in London at Pacific Investment Management Co., which manages the world’s biggest bond fund. “He’s saying what’s important isn’t just the path of market expectations, but the path delivered by the BOE and keeping short rates anchored even if longer yields go up.”
Those people may already be listening. The number of households expecting the BOE to increase rates in the next two years fell to 40 percent this month from 53 percent in July, according to a Markit Economics Ltd. poll.
Amey said policy makers may eventually have to “rail back against interest rates going up,” most likely with more quantitative easing, through that point isn’t here yet. Carney addressed that, noting risks from market expectations and saying the Monetary Policy Committee was ready to act if this undermined the recovery.
“The upward move in market expectations of where bank rate will head in future could, at the margin, feed into the effective financial conditions,” Carney said in his speech. “If they tighten, and the recovery seems to be falling short of the strong growth we need, we will consider carefully whether, and how best, to stimulate the recovery further.”
U.K. unemployment was 7.8 percent in the second quarter and the MPC doesn’t see it reaching the threshold until the end of 2016. Carney sought to reassure executives who may share some economists’ view that it will fall faster, saying that even if that happens, it’s not a catalyst for tightening.
It’s a “staging post to assess the economy,” he told the assembled crowd. “Nobody should assume that it is a trigger for raising rates.”
U.K. gilt yields have risen in part because of indications of strengthening U.K. growth and the U.S. Federal Reserve’s signals that it may begin trimming its bond purchases, currently running at $85 billion a month.
“They have to try to decouple as best they can,” said Azad Zangana, an economist at Schroder Investment Management in London. “The problem is the market just doesn’t really believe them given the forward guidance they’ve provided.”
The BOE may have added to upward pressure on longer-dated yields after it said yesterday it will relax liquidity requirements for banks meeting capital targets. That will allow them to reduce required holdings of low-yielding, easy-to-sell securities, such as government bonds. Tinsley said the move is “not particularly supportive” for gilts.
Investors skepticism has also been fueled by dissent on the MPC. Several officials questioned guidance before Carney’s arrival, and Martin Weale voted against it this month because he wanted the inflation-escape hatch to be bigger.
While the MPC voted to keep its QE program on hold this month, some members said the case for more was “compelling.” They added there was “merit in first supporting” guidance and waiting to assess its impact. Zangana, Tinsley and Amey said votes to restart bond purchases would be a possibility at future meetings for those officials concerned about higher rates.
“The obvious next step would be to resume quantitative easing,” Vicky Redwood, an economist at Capital Economics in London and a former central bank official, said in a research note. “If the MPC decides to show its teeth, there is plenty of scope for rate expectations and gilt yields to fall back.”
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