InvestmentsNov 10 2015

Cautious BoE strikes different tone to Fed

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Cautious BoE strikes different tone to Fed

The Bank of England and US Federal Reserve look to be diverging monetary policy after the former’s latest inflation report struck a downbeat tone.

Last week, in a move that caught markets by surprise, BoE governor Mark Carney potentially pushed back the timeline for a UK interest rate rise once again.

The central bank’s November inflation report trimmed growth and inflation forecasts, and though Mr Carney said households should prepare for rates to rise “next year”, sterling fell in the belief that a hike had been pushed back.

Gam investment director Charles Hepworth said after the report that central banks “are waiting for that window that they can all start to lift off in lockstep fashion”, but US and the UK policy outlooks now look very different.

The BoE’s cautiousness contrasts with the US Federal Reserve’s suggestion on October 28 that a December rate rise was still on the table.

Notably, the Fed said that global growth risks had receded since September, but the BoE continued to strike a cautious note on the outlook for the world economy.

The sense of diverging policy moves was reinforced on November 6 when US employment figures easily exceeded expectations, leading some to predict that a December rate hike by the Fed was a near-certainty.

Howard Archer, chief European and UK economist at IHS, summed up the prevailing mood when he said: “A strong US jobs report following straight after a dovish Bank of England inflation report fuels the belief the Fed will hike in December and well ahead of the Bank of England.”

John Pattullo and Jenna Barnard, managers of the Henderson Strategic Bond fund, said on social media that UK monetary policymakers now appeared closer to their European counterparts than their US peers.

“Bank of England sounding more like [European Central Bank] than Fed. Flip flop,” the pair said.

A week before the Fed meeting, the ECB’s president, Mario Draghi, said it would re-examine whether further quantitative easing on top of its current €1.1trn (£779m) package was needed.

The ECB will now conduct a “thorough analysis” on the “strength and persistence” of economic factors keeping inflation below the target of 2 per cent.

While Mr Carney took the unusual step of clarifying that the BoE had not discussed further easing measures, Royal London Asset Management senior economist Ian Kernohan noted the market was expecting a more hawkish inflation report on the back of the Fed comments.

“The Bank sent quite a dovish signal and certainly [was] not signalling an imminent upward move in rates.

“Inflation is expected to remain below 1 per cent until the second half of next year, and projected to be a little above target in [three years], assuming current market rates. This overshoot doesn’t look material enough to be viewed as a warning shot. We expect the Bank to hike rates in 2016, but not until the middle of the year.”

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, agreed with Mr Kernohan’s views and said the BoE’s report was more “nuanced” than simply ruling out a rate rise in 2016.

“[We] believe the door is still open to an interest rate rise in the second quarter of next year,” he said.

However, Mr Tombs said nothing in the minutes of the BoE’s latest meeting suggested much future dissent in the vote of Monetary Policy Committee members, currently eight to one in favour of keeping rates on hold.

A move by the US to raise rates could yet prompt the BoE into action, he said, given that this would likely erase some of sterling’s strength. Mr Carney has suggested the strong pound is holding back both inflation and the need to hike domestically.

Mr Tombs said: “The MPC’s forecasts are also underpinned by the assumption sterling follows the path implied by forward rates.

“This means it assumed the pound holds steady. But if the Fed raises rates as quickly as we expect [just below 2 per cent by 2017], the MPC will need to prop up sterling to prevent exceeding its target.”

With no meeting in November, the Fed’s next monetary policy announcement is scheduled for December 16.


Salman Ahmed, global strategist, Lombard Odier IM

Creating hawkishness ahead of the Fed meeting could be quite costly in terms of currency appreciation risk, which the Bank of England note is [increasing] downward pressure on inflation. In a world of global disinflation and currency musical chairs, it requires a lot of confidence in the outlook to commit.

Peter Cameron, fund manager, Eden Tree Investment Management

With half the world’s central banks cutting rates or planning to expand their own QE programmes, the Bank of England will be worried that hiking now could push up sterling and trigger further deflationary pressures. Therefore the record-low 0.5 per cent base rate may well be celebrating its seventh birthday in March.

John McNeill, fund manager, Kames Capital

One new piece of information is that the BoE have suggested that they are unlikely to sell any of the gilts [purchased via quantitative easing] until bank rate has reached a level of 2 per cent. Given that it is likely to be some considerable time until bank rate reaches that level, the BoE will be reinvesting redemptions for the foreseeable future.