MacroScope

UK rate consensus nearly rock-solid even as markets flip-flop over timing

August 20, 2014

BFor all of the flip-flopping in sterling markets in recent months over when the Bank of England will finally lift interest rates off their lowest floor in more than 300 years, the consensus view among forecasters has been remarkably stable.

Not only that, but surprise news that two of the nine members of the Monetary Policy Committee voted this month to hike Bank Rate by 25 basis points to 0.75 percent does not seem to have shaken the view that it will be early next year before rates go up.

The Reuters Poll consensus — which the BoE uses to brief the MPC on policy expectations and cites each month in the minutes — has concluded on each occasion since March that a UK rate hike is not going to happen until the first half of 2015. Before March, the view was that it was likely to take even longer.

Yet despite all the recent talk of a rate rise this year, it has never come close to being the consensus.

Many analysts have concluded that Mark Carney’s hawkish speech in June to the Mansion House where he warned that a rate rise come sooner than many currently think was simply an attempt to shake markets out of their complacency.

As the previous policy of forward guidance appears to have worked in creating solid expectations for no move this year, Carney’s speech also appears to have worked by injecting plenty of volatility back into markets but leaving the majority view on a rate hike for early 2015.

What Martin Weale and Ian McCafferty, the two dissenters on the MPC, didn’t know when they cast their vote for a rate rise was that inflation fell sharply in July to 1.6 percent. The assumption made in the Inflation Report that it would likely hover just under the 2 percent target was wrong.

They might have taken a different view had they known.

Fathom Consulting wrote in a note:

 There are passages in today’s Minutes that suggest a number of members may not be ready to vote for a hike for some time yet, and indeed may even be harbouring a lingering easing bias.

 Moreover, historically dissenting votes have signalled that a policy change is imminent no more than half of the time.

 Philip Shaw, chief economist at Investec, agrees in principle:

 We would make the point that it does not automatically follow that momentum will build quickly for a tightening simply because two MPC members have voted for a hike.

 Indeed in May 2011, three individuals supported higher rates, but all had backed down three months later as the outlook for the economy had deteriorated.

Back then Martin Weale, along with former MPC members Spencer Dale and Andrew Sentance, voted for a hike, only to back off that call when the economy, and inflation, took a turn for the worse.

The European Central Bank, under President Jean-Claude Trichet, jumped the gun and raised rates roughly around the same time in an attempt to ward off what turned out to be a very temporary spike in inflation.

His successor Mario Draghi came in and had to reverse that in a hurry. Even after managing to put the euro zone debt crisis on ice Draghi is struggling with a stalled economy and dangerously low inflation that shows no signs of perking up any time soon.

But there does not appear to be much chance the BoE is likely to make the same mistake. Like the U.S. Federal Reserve, the MPC is more likely to err on the side of more inflation than risk triggering a relapse in economic growth.

Fathom says:

We continue to expect the first policy tightening to come in the early part of next year, but more importantly we expect the pace and extent of any tightening to run behind inflation and hence disappoint market expectations and sterling bulls.

Even the City’s biggest rate hawk, Citi’s Michael Saunders, backed off a very public Q4 2014 rate call after a dovish Inflation Report last week.

And, with the MPC’s greater emphasis on average earnings growth (which may stay weak for a while amidst the expansion of jobs in low-pay sectors), we also have scaled back our forecast for the initial pace of hiking, and now expect Bank Rate to hit 2.5% around mid-2016 (previously end-2015).

The upshot is that the committee can be split for a while yet and, as the Reuters Poll has said for quite some time, UK rates probably are not going to rise this year.

– additional reporting by Deepti Govind

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