Does the Bank of England really follow the Fed?

July 21, 2015

???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????“Daft” is how outgoing Bank of England policymaker David Miles described the idea that Britain’s central bank would have to wait for the U.S. Federal Reserve before hiking interest rates.

Central bankers are always keen to stress their independence. But has the BoE tended to be a Fed follower or driver?

Economists are sceptical that the BoE will move first.

That’s mainly on the grounds it probably doesn’t want a further rise in sterling, which is already at a 7-1/2 year high on trade-weighted basis in anticipation of higher rates.

All 20 economists who responded to a Reuters poll said it was unlikely the BoE will jump in front. The consensus points to a September move for the Fed, followed  by a February rate hike for the BoE — a view that was unmoved by Miles’ remarks or comments from Governor Mark Carney that some viewed as hawkish.

But the real answer to the question isn’t completely straightforward.

BoE-fed

The Monetary Policy Committee took over the task of setting British rates in June 1997, and went about completing a small tightening cycle over the next few months that the Treasury had already started.

Thereafter, the Committee followed the Fed’s lead in each tightening and loosening cycle for the next six years.

  • Mid-late 1998 easing cycle: Fed led by 1 month
  • Mid-1999 to mid-2000: Fed led by 3 months
  • Early 2001 cutting cycle: Fed led by 1 month
  • Nov 2002: Fed cuts rates, BoE followed 3 months later
  • June 2003: Fed cuts rates, BoE followed 1 month later

But from late 2003 through to late 2007, things go out of sync.

  • Late 2003 to August 2004, the BoE embarked on a tightening cycle of its own
  • June 2004 to June 2006, the Fed began a tightening cycle
  • Second half of 2006 to July 2007, the BoE tightened some more — a period in which the trade-weighted sterling index rose to its highest since records began dating back to 1990.

That brings us to the start of the financial crisis.

  • September 2007, the Fed cuts — followed 3 months later by the BoE.
  • October 2008 — the Fed and BoE cut rates in a posse of global central banks as all hell breaks loose.

Again, the main reason why most are sceptical that the BoE would consider hiking rates before the Fed is the strength of the pound. An early rate hike by BoE could well send sterling spiraling even higher, compounding the effect of monetary tightening by an uncertain degree and putting downward pressure on imported inflation, when inflation is already near zero.

“We think that it is very unlikely that the Bank of England will raise rates before the Fed, and indeed there is likely to be a significant delay. The U.S. economy has underlying strength and can take a rate rise, however we do not feel that the UK economy is strong enough yet. As things stand, the Fed will almost certainly raise rates before the Bank of England,” said Oliver Jones, economist at Fathom Consulting.

Trade-weighted sterling:

GBP - trade-weighted

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