The Fed Should Listen Closely to Britain's Recession Talk
Bank of England Governor Mark Carney has broken a central banking taboo. In today's press conference he used the "R" word -- recession -- in detailing the risks facing the U.K. economy if the nation votes to quit the European Union at its June 23 referendum.
While Europhobes might accuse Carney of scaremongering, his comments reflect a wider unease about the anemic state of the global economy, a malaise that the Federal Reserve has yet to fully take on board.
In the U.K., where the central bank looked likely to follow the Fed in starting to push up borrowing costs, that deteriorating outlook is making a rate cut more probable than an increase. Here's a chart showing how traders are currently pricing expectations for U.K. monetary policy in the coming year:
The Bank of England's nine-member committee voted 9-0 for unchanged interest rates today. But with the central bank cutting its growth forecasts through 2018, at least two members appear to be learning toward easing.
In March, the bank's Chief Economist Andy Haldane said he saw no "immediate case" for a policy change, but that "policy may need to move off either foot in the immediate period ahead, depending on which way risks break." That was back when economists were predicting that annual inflation would reach about 1.7 percent by now. But those forecasts have dropped further away from the central bank's 2 percent inflation target:
Given that Haldane thought the backdrop was "evenly balanced" just over a year ago, the deterioration since then in the price environment and the implications for inflation returning to its target pace suggests his vote to hold may have been a close call. He's not the only one whose arguments suggest growing pessimism. Gertjan Vlieghe, who joined the rate-setting panel in September, said in an interview last month that "theoretically, I think interest rates could go a little bit negative." He told a committee of lawmakers in February that he would consider cutting interest rates if economic data continued to prove disappointing:
I have relatively little tolerance for further downside surprises, and should downside surprises continue then I think we will get relatively quickly to a point where I find it appropriate to respond to it.
There's no question that there have been more U.K. downside surprises since then. If the bad news continues -- especially if Carney's warning of a Brexit-induced recession comes to pass -- Haldane and Vlieghe will need to start nudging their colleagues towards cutting the bank's key interest rate, which has been stuck at 0.5 percent since 2009.
Fed officials seem to be a world away. The Federal Advisory Council said on Tuesday that "one or two well-timed and well-communicated increases" this year would be "prudent." In the futures market, though, you have to look all the way out to February 2017 before the chances of higher borrowing costs surpass 50 percent.
Traders have spent the past two months scaling back their bets on a second U.S. rate increase at the Fed's July meeting. Futures contracts now suggest just a 4 percent chance of a hike next month; at the subsequent meeting, the likelihood has more than halved since the middle of March to 17 percent:
Given that everyone from the World Bank to the International Monetary Fund to the Organization for Economic Cooperation and Development is getting gloomier about the global outlook, the course the Fed charted at the end of last year looks increasingly far-fetched.
The Fed has had to become more mindful of what's happening beyond its monetary borders, even though its mandate is strictly domestic. With the European Central Bank and the Bank of Japan both stepping up their economy-boosting efforts, and the Bank of England increasingly likely to tilt toward easing policy, a further increase from the Fed would be an unwelcome burden on a global economy that's still struggling to recover.
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