Dovish BoE defies inflation prediction
Morning mid-market rates – The majors
5th November: Highlights
- Bank of England leaves rates unchanged, but warns of coming increases
- Productivity collapsed in Q3
- Slowing activity supports ECB dovishness
Highest inflation forecast for a decade
The two members who voted for a hike were David Ramsden, Deputy Governor for Banking and Markets, who is concerned about what he calls rampant wage demands over the next few years and Michael Saunders.
Saunders is a perennial hawk who believes that the level of support being provided to the economy risks fuelling expectations of higher inflation.
The vote to hold fire on any rate increase came despite the Bank’s latest forecast for medium term inflation, showing that price increases could reach 5% by next April.
At his press conference following the meeting, Bank of England Governor, Andrew Bailey commented that it is not the job of the MPC to act in accordance with market expectation. In that regard, Bailey is being compared to his predecessor, Mark Carney, who earned the reputation of being an unreliable boyfriend, often hinting at action by the Committee, only to fail to follow through when the meeting voted.
He went on to say that it is likely that interest rates will need to rise in the coming months to combat rising inflation
Bailey has risked his credibility by hinting strongly that interest rates would be hiked at this meeting. He responded, when questioned, by saying that every vote is independent, and he has no power over how members vote.
Bailey will have gauged the expected mood of the meeting before making comments that led the market to believe that rates were going to be raised, so the result will have severely dented his credibility.
In the recent past, the committee has been split between those who work at the Bank and independent members, but this time, the votes to hike came one from each side.
The pound fell to the lower end of its recent range following the meeting. It reached a low of 1.3471, closing at 1.3497.
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Powell believes that predictability makes actions effective
The headline number for new jobs created as well as any revision to the September data are both being seen as closer to the figures that were being seen in the summer.
With no evidence to back this expectation, it is probable that the risk is for the data to, yet again, disappoint.
The comments from the Chairman of the Federal Reserve following the meeting of the FOMC earlier this week were fairly neutral despite the start of the taper of additional support being announced.
Jerome Powell believes that inflation will begin to fall naturally, early in the New Year but also believes that the economy has some way to go before it merits an interest rate hike.
Powell has been at pains to say that the Fed won’t be swayed by an individual dataset, or one month’s data, but the market appears to have taken a bullish inference when looking at today’s data.
The latest prediction is for around 500k new jobs to have been created in October and an upwards revision of close to another 150-200k new jobs having been added in September.
It has become a popular urban myth that the Coronavirus pandemic is over despite numbers of cases continuing to rise. This continues to be a drag on the economy. Official data shows that the spread of the virus has become more regionalized, but the Pandemic is far from over.
Additionally, the bottlenecks being seen globally in supply chains, although abating a little, are still a significant drawback for growth.
It is true to say that despite the beginning of the taper, the reduction of additional support will have very little effect on the factors driving inflation higher since they are on the supply side of the economy while demand continues to rise.
The divergence of the U.S. and Eurozone economies and the measures being taken by their Central Banks continues to drive the single currency lower. The dollar index rose again yesterday to a high of 94.47, closing at 94.32. This was its second-highest close since November of last year. Expectations remain that a break above resistance at 94.50 will be seen irrespective of the result of today’s employment report.
Supply issues are still the biggest issue
This is something of a departure from experience and is an almost complete referral of the way the personalities of Christine Lagarde and her predecessor Marion Draghi were expected to play out.
Draghi is a pragmatist bureaucrat used to acting on the facts and what he can see with his own eyes. This has been shown several times in his new capacity as Italian prime Minister.
However, Lagarde is far more flamboyant, more used to the grand gesture. She was expected to be an agent of change at the ECB given her past actions when President of the IMF, a role she clearly relished.
She is still ambitious and may have political aspirations. But for now, she has been content to drive a quiet revolution, changing the entire outlook of the Bank away from inflation to focus on growth.
Her belief is that countries that are growing will see debt to GDP ratios and budget deficits fall naturally, and it will then follow that monetary policy will be a far more effective tool in combating inflation.
The more reactive nature of the bank is also a first, with pressure often being exerted at the first whiff of rising wages or prices.
Lagarde has been very straightforward with the market. She may have been a little premature in the summer, announcing a change in inflation policy before it had actually agreed but it is eminently clear that she had sufficient backing to combat any doubters.
Now, a more middle of the road Central Bank is emerging, able to react to policy issues as they arise and acting in accordance with its stated objectives.
One victim of this change in policy has been the weakness of the euro. While this is inflationary in its own right. It is believed that the benefit to exporters outweighs this risk.
Yesterday, it fell to a low of 1.1528, closing at 1.1554 as the market’s view that it will break below 1.1500 imminently appears to be coming to fruition.
About Alan Hill
Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”