UK rate rise this year? Possible, but not certain yet

June 13, 2014

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“It could happen sooner than markets currently expect.”

That was the bomb of a headline Bank of England Mark Carney dropped in a speech on Thursday that suggested a significant change in tone at the bank.

So far, Carney has seemed comfortable with keeping rates at a record low of 0.5 percent for another year. That has been the forward guidance markets have been following.

But are many now convinced that Bank Rate will go up earlier?

Not yet, but some.

Given that Carney’s remarks come only a month after he outlined a dovish outlook for rates in the May Inflation Report, he took many by surprise, sending sterling to just under $1.70 and rallying to less than 80 pence per euro.

A 10 percent rise in sterling over the past year has already been doing some of Carney’s tightening for him.

And short sterling interest rate futures are now pricing in a 25 basis point rate rise by December.

But Carney’s full remarks are more balanced than the headlines suggest.

Much will depend on how quickly the economy runs down spare capacity in the economy, which the MPC still judges to be between 1-1.5 percent. He suggested that pace may slow in the second half of the year. That would likely delay any rate rise. Pay growth has not kept up pace with employment growth either, which will be key, especially toward the end of the year.

And Carney has made clear that taming the housing market will be up to the new Financial Policy Committee, which meets next week and is widely expected to launch a series of new measures.

Despite the sharp moves in sterling and rate futures, there have been only a few rate forecast changes by City banks. Only 10 of 45 polled by Reuters after the speech expect a rate hike this year, athough the consensus now has shifted to Q1 next year from Q2. And several economists told Reuters they may revise forecasts early next week.

George Buckley, Deutsche Bank (changed to November from May 2015):

Two years ago the headlines following the annual Mansion House speeches were all about the announcement of the BoE/Treasury’s joint venture of the Funding for Lending Scheme. This year, the focus is on just eight words within the Governor’s speech, in reference to expectations of the first hike in interest rates: “It could happen sooner than the markets currently expect”.

So often central bank speak is hedged – but in failing to simultaneously talk about any risks of interest rates being raised later than yesterday’s market pricing the Governor has made it very clear that we should be gearing up for a rate rise later this year. Indeed, before the speech the markets were pricing in the first tightening in policy around the first quarter of next year. As a result, we have brought forward our view following Mr Carney’s speech by a full six months – from May next year to November this year.

This is the only Inflation Report month the MPC can now start the process of tightening that would be consistent with the Governor’s comments, assuming that a move up in August is too soon. Moreover, it could even be the case that one or more MPC members have already voted for higher rates, which would be revealed in next week’s minutes from the June meeting. More likely, we believe, is that the first vote for higher rates will come in August – which we have brought forward from our previous view of November.

Victoria Clarke, Investec, commenting as well on revised UK construction data in Q1 that could boost Q1 GDP data:

Against this backdrop, it is not hard to see why Bank of England Governor Mark Carney felt it necessary to put markets, households and businesses ‘on notice’ for a forthcoming interest rate hike over the months ahead in his Mansion House speech last night. From a position in May (at the Inflation Report press conference) in which Mr Carney seemed relatively relaxed about the level of spare capacity and scope to sit back before tightening policy, the Governor himself even appears to have been taken a touch by surprise at the pace of improvement in the recovery, particularly on the jobs front.

Mr Carney indicated last night that rates could ‘rise sooner than markets expect’ whilst stating that the case for raising rates was becoming ‘more balanced’. This was the most hawkish speech yet from Mr Carney at the Bank. Whilst the June MPC meeting will not have had full sight of the latest jobs report, Mr Carney’s tone was suggestive of the Committee having moved into interest rate ‘normalisation’ debate mode and that the minutes to the June meeting (to published next week) will show the Committee edging closer towards tighter policy. Mr Carney’s words clearly open wide the possibility of a rate hike towards the latter point of this year, by which point we are likely to have observed further strides in the UK’s jobs recovery. That likely means that the November ‘Inflation Report’ becomes a key focal point, with a hike at that point allowing the MPC to test the resilience of the UK’s recovery to higher rates, with an early move, well ahead of the May election.

HSBC’s Simon Wells (for now, sticking to forecast for first rate hike in Q3 2015):

While noting that the precise timing of the first rate rise will be data dependent, this shift increases the risk of a rate rise this year. However, the MPC will probably want to see more data before pulling the trigger, making wage growth and productivity data more important than ever. Mr Carney also confirmed that the BoE is considering using macroprudential tools to calm the housing market. So some kind of FPC announcement on 26 June is very likely.

In a significant shift in tone from last month’s Inflation Report, Mr Carney sounded more hawkish and seemed to be preparing the market for the possibility of earlier rate rises. He reiterated that the monetary policy decision was becoming “more balanced” and “it could happen sooner than financial markets currently expect”. However, this was nuanced by stating that the MPC has “no pre-set course” and that the ultimate decision will depend on data.

Having repeated that eventual rate rises would be limited and gradual, Mr Carney seems to be hinting that rate rises may need to start sooner if the output data stays strong – something mentioned in the May MPC minutes. However, he seemed to rubber-stamp the market curve of rates rising to 2.25% over the next three years. So if the tightening cycle were to start earlier than expected, the path might be more gradual than 25bps per quarter.

Mr Carney’s comments suggest a change of stance by one of the MPC’s most dovish members. As such there is now a much bigger risk of tightening much earlier than our expectation of Q3 2015. However, the MPC will probably want to see a little more data before it pulls the trigger, in order to judge whether the pace of erosion of slack may be slowing in the second half of the year, and also to wait for signs of stronger wage growth.

Michael Saunders, Citi (already had a forecast for Q4 rate hike, rising rapidly to 2 percent by the end of Q3 next year):

In our view, this speech marks an important change of tone from the Governor, removing any sense that the MPC is on auto-pilot and locked into inaction until some distant preset date. We continue to expect that strong economic growth and the tightening labour market will prompt the MPC to start to hike before year end, with rates rising earlier, further and faster than markets currently price in.

Dirk Schumacher, Goldman Sachs (no rate rise until at least Q2 2015 in latest forecast before Carney speech):

BoE Governor Mark Carney provided a distinctly hawkish message, suggesting that while “the MPC has no pre-set course … [the first increase in Bank Rate] could happen sooner than markets currently expect.” Prior to the speech, the first full rate rise was priced in by Q1 2015. While Carney tempered his comments by emphasising that a rate hike was not imminent and “that eventual increases in Bank Rate will be gradual and limited“, the speech nevertheless signals a material change in tone from the previously dovish comments of the Governor.

Jacqui Douglas at TD Securities had a more practical interpretation of Carney’s remarks:

The Mansion house speech is often market-moving. But I didn’t expect much this time because recent economic data hasn’t surprised. We suspect this had less to do with pulling forward rate hike expectations but more to do with reducing market complacency and increasing volatility, to shake things up a bit.

After the ECB rate decision last week, there has been so much talk of carry trades that central bankers are kind of getting worried of the current situation in which interest rates are too low for way too long. So, I think he did it to wake people and try to get some of the complacency out.

The other reason is the latest BoE minutes, which come out next week. I suspect we might see a little more anxiousness, not outright dissent in deciding a rate hike and Carney may have wanted to get an edge before the minutes come out.

And Stephen Lewis of Monument Securities (sticking to Q2 2015 for 25 bp rate hike) says it’s politically-motivated:

I think it was done to prevent widespread speculation that rates will remain low for a long period. It is significant that following that one statement, Carney went on the include a rather huge comment about it (first rate hike) being data driven, so technically the policy hasn’t changed. Carney wants us to believe that it is not a politically driven move and not influenced by next year’s election. 
– Additional reporting by Sumanta Dey and Ashrith Rao Doddi
* Blog updated with latest Reuters Poll on UK interest rates
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