On Thursday night the Governor of the Bank of England delivered a very nuanced speech at Mansion House. However, his eight word reference to the possibility that Bank Rate might increase sooner than markets expected seems to have surprised quite a few market observers. Naturally, any shift in the Bank´s stance on monetary policy has important implicactions for all sectors of the economy in the short-run, when looking out more-or-less over a two year time span. As well, it led to a noticeable move higher in sterling, towards levels (1.70) which traders had previously pointed out as a sort of 'line in the sand' for the Old Lady on Threadneedle Street. Hence, at Sharecast we have attempted to better gauge the first reactions from some leading economists.
As is often the case, the media simplified what was a complex speech, full of caveats. However, Dr.Carney´s speech does effectively mark a reset in terms of the framing of the MPC debate. One must not forget that Carney was one of the most dovish on the MPC. Hence, the centre of gravity has clearly shifted. As well, the Governor said that macroprudential tools, if used as insurance, "won't necessarily affect the path of interest rate increases". This is strong stuff - measures to damp the housing market should not be viewed as meaning rates will be lower than otherwise. Thus, a first increase in policy rates in the fourth quarter of 2014 is now looking very likely. A move higher before then still looks like a stretch given the changes expected in the composition of the MPC over the coming few months. But it is no longer impossible and is now data dependent. By the time of the August Inflation Report we will see one or two MPC members voting for a hike, opines David Tinsley, UK Economist at BNP Paribas.
Carney´s failure to immediately offset in his speech last night the phrase "[an interest rate increase] could happen sooner than the markets currently expect" with any reference to risks lying on the other side was done on purpose. For that reason a first increase in Bank Rate can now be expected in November of this year, instead of in May of next. In parallel, a first vote from a member of the MPC in favour of a hike in rates is likely at the August meeting, instead of November. Bank rate will be at 1.50% by the end of 2015, 2.50% by the end of 2016 and 3% by the end of 2017, Deutsche Bank´s George Buckley writes.
The Governor´s plunge towards the hawkish camp must be interpreted in the light of his dovish remarks as recently as last month´s Inflation Report. Though not without caveats his remark that an increase in Bank Rate could come sooner than markets were expecting underpins the likelihood that the Bank will become the second developed world central bank to act on interest rates, after the Reserve Bank of New Zealand. Consensus still expects the BoE´s cycle of rate increases to begin in the second quarter of next year, as we have long held. We will be re-evaluating our view on the back of the above remarks, but we will wait for the release of the most recent set of minutes, due next week, before publishing a revision, says Rabobank´s Jane Foley.
While we have been insisting that policy divergence will be a major driver of FX markets, especially in Europe, the pace of events is unfolding even more rapidly than we had envisaged, with BoE Governor Carney warning that rates in the UK could rise more quickly than the market had been pricing in. Yes, although noting that there is still some slack in the economy, Carney warned that the interest rate decision was becoming more balanced, hinting that a rate hike could come this year rather than in spring 2015. "This could see the market switching its attentions to as early as the November or even our October MPC meeting, providing GBP
with a further boost," according to Bill Hubard, Chief Economist at Markets.com.
This was the most hawkish speech yet from Governor Carney and comes after in May he had seemed relatively relaxed about the level of spare capacity in the economy. Even the Governor himself appears to have been taken a touch by surprise by the pace of improvement in the economic recovery, especially on the jobs front. His words clearly leave the door open to a rate hike towards the latter end of this same year. An increase in Bank Rate in November will allow the Monetary Policy Committee (MPC) to test the resilience of the economy to rising policy rates. The tone of his speech also suggests that next week´s minutes will show a Committee edging closer to a first increase, says Investec´s Victoria Clarke.