Carney leads analysts to water, but can’t make all of them think

November 12, 2014

BBank of England Governor Mark Carney has given probably the clearest signal that rates aren’t going to rise for another year, and yet many analysts who are paid to predict and track the Bank’s every move seem to be in more of a muddle than ever before.

But this time there isn’t a good explanation for their confusion. “Forward guidance” is over, and the inflation forecast, along with incoming data, is what matters. This, after all, has guided BoE policy for the vast majority of its years as an independent central bank since 1997 and should be right in their comfort zone.

The November Inflation Report forecast is saying inflation will be slightly below 2 percent at the target horizon based on current market pricing on where interest rates will go. Financial markets have moved, over a period of about five months, from fully pricing in a rate hike this month to not pricing one in for another year. But many analysts are still stubbornly forecasting a rate hike in the first half of next year.

To be fair, many people in financial markets may also think they are smarter, and that policymakers are the ones who are wrong. And indeed, they might have good reason to do so given that policymakers, like traders, investment managers, and hedge funds, often make mistakes and have to correct them afterwards. (For recent policy examples, see: European Central Bank; Riksbank; Bank of Japan). 

But what many forecasters seem to have forgotten is that however poor they think policymakers’ track records may be for setting good policy, the Monetary Policy Committee sets the policy, not analysts or financial markets trading the pound, interest rate futures, government bonds, or anything else. 

And when the MPC does raise Bank Rate, whether or not the vote is split, the outcome won’t be a surprise to the BoE when it tells the world what it has just decided to do.

But it’s even more simple than that. Carney has clearly said that inflation is going to fall sharply in the coming months. This is not a UK story but a tale that stretches across the globe.

The near-term weakness means that it is more likely than not that I will have to write an open letter to the Chancellor in the next six months on account of the inflation rate falling below 1%.

In other words, Carney has just prepared the markets for likely policy error in the opposite direction.

If that happens, it would be next to impossible for him to talk his way out of why he has raised rates when current policy (and clearly also to a large extent falling oil prices) has led to inflation that is too low, not too high.

Consider as well that raising rates ahead of a general election — scheduled for early May — is something any central bank in any country would prefer not to do if given the choice, and you have just about the clearest short-term path for interest rates you could ask for. They are going nowhere.

And yet an astonishing number of forecasters still are clinging on to the view that UK Bank Rate, which has been at a record low of 0.5 percent for more than half a decade, will be going up by the middle of next year.

Some of them were spooked by news that wage inflation outpaced inflation by a tiny margin for the first time in five years.

But what that masks is the fact the reversal is been driven primarily by falling inflation, not a sudden surge in pay.

Michael Saunders at Citi, who published about a year ago an extremely aggressive set of forecasts for interest rate hikes, expecting a rate hike by end-2014, 100 basis points by the middle of 2015 and who still is forecasting 1.75 percent by the end of next year, had this to say to clients:

… even while low near-term inflation makes the timing of the first MPC hike highly uncertain — we go for Q2-2015 — over time we suspect that the continued tightening in the labour market means that the MPC will need to hike more than markets price in.

If clear signals coming from the UK economy — which is slowing — and from the Bank of England — which is warning that rates aren’t going anywhere — aren’t enough, there is also the rest of the world to consider. 

Inflation is falling or holding at very tame rates in just about every economy Britain trades with, with a few notable exceptions in emerging markets where central banks are already acting aggressively to manage their exchange rates. Even China’s inflation rate has nearly caught up to the UK’s fall, coming in just 0.4 percentage points above at 1.6 percent. Its vast industrial sector is deflating.

The Bank of Japan has just launched another round of aggressive money printing because it’s worried that past measures weren’t enough and that deflation could set in yet again.

Huge swathes of the euro zone are now deflating and Germany, supposedly the growth engine of the European continent, is inflating by less than 1 percent. The European Central Bank is shoveling out a new policy move just about every month, desperately trying to avert outright sovereign bond purchases, which Germany staunchly opposes.

Sweden’s Riksbank has just slashed rates to zero after a disastrous experiment raising them prematurely, bringing about deflation. It has a staggering number of similarities with Britain, from sky-high household debt to a national obsession with its property market.

Inflation is even on the wane in India, where an interest rate cut is the most likely next move.

And in the United States, which just shuttered its money printing last month, several years after the BoE stopped its own programme, it is far from certain that rates will be rising by the middle of next year as markets currently expect.

Lena Komileva of G+ Economics, one of the most consistently dovish, and accurate, forecasters on UK monetary policy over the past year, says this is just one chapter of “the global disinflationary story”:

The BoE’s November Inflation Report has reinforced our long-held view that UK rates are going nowhere before the middle of 2015.

A constellation of dovish factors is now the centre ground for UK rate projections, given falling inflation expectations and a depressed UK CPI outlook, from the starting point of a 5-year low, weak domestic labour costs, slowing global demand, stalled Eurozone momentum, adverse geopolitical climate, lower global commodity prices and earlier sterling exchange rate strength.


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