The Bank of England Monetary Policy Committee’s November 12 Inflation Report will have a sharply lower near-term inflation forecast but rather than endorsing market hike expectations, Governor Mark Carney will likely stress that the path of rate hikes is more important than focussing on when they begin.
While the near term central inflation projection in the August Inflation Report will be pushed down, it could well be shown rising close to the 2.0% target towards the end of the forecast horizon, which would make it a policy neutral report.
Carney, like his Deputy Ben Broadbent, has said he has little time for the markets’ obsession with the timing of that first hike.
Instead, the governor will want to ram home the message that keeping rate hikes gradual and limited – in the region of around 25bps a quarter – is more important for anyone in business.
Those making a living in sterling markets may be disappointed, but Carney has mocked the obsession with the timing of that first hike, saying at the August Inflation Report press conference that it “is important if you are trading short sterling, but not so much in the real economy”.
Speaking in an interview with Bloomberg in July, Deputy Governor Broadbent piled in to rib those “utterly fixated on this first date”.
So any comments by Carney to either endorse or contradict current market rate hike expectations would be striking, to say the least, and would leave him wide open to charges of a U-turn.
Broadbent, and colleagues, will also privately address City economists after the publication of the report – but the deputy governor is wary of discussing not just when the first hike will come but also where precisely Bank Rate is likely to settle long-term.
A trawl through Broadbent’s speeches since joining the MPC back in June 2011 show a pattern of tackling tricky topics, from the current account deficit through the neutral real rate, while steering clear of saying anything that illuminates his likely future voting preferences.
Critics highlight the way the majority on the MPC have found new ways of pushing back rate hike expectations when spare capacity is shrinking apace, but have been quick, in Chief Economist Andrew Haldane’s or Deputy Governor Jon Cunliffe’s cases, to suggest rates can stay lower for longer at early signs of trouble.
As Ross Walker of RBS notes, it needed several quarters of capacity-reducing above-trend growth to nudge the Bank towards a ‘hawkish’ bias – with Carney warning in June that Bank Rate rise ‘could happen sooner than markets currently expect’.
“By contrast, several weeks of financial market jitters, evidence of a faltering recovery in the euro area and ongoing anaemic wage inflation data in the UK have been sufficient to drive a significant change in market sentiment this autumn,” Walker said.
Bank Rate has now spent well over five years slammed down at its record-low emergency 0.5% setting.
Market expectations are for it to make it comfortably beyond six in 2015, with rate expectations for the first hike having moved back to August 2015, having moved forward in June to this November after Carney’s rate hike warning.
The August Inflation Report had CPI on market rates at 1.77% two years ahead and 1.96% three years on, so extending that upward slope forward a quarter would see the final figure a sliver over 2.0%.
Food and energy prices are falling across developed economies and headline CPI has moved markedly lower than forecast in the August IR, coming in at 1.5% in the third quarter compared with the 1.8% the BOE August IR forecast, and the MPC’s 1.9% forecast for Q4 will surely also be cut.
While inflation has been running softer than the MPC expected, the lower market rate expectations, which have fed through into lower mortgage rates, and the dip in trade weighted sterling will help dampen the impact of the deterioration in the non-US global outlook.
The central inflation forecast, however, does not tell observers what would happen if rate hikes were to follow a different path than the market one. An earlier initial hike, followed by slightly slower tightening, for example, could result in the same end point.
A complaint from some analysts is that it is unclear precisely what metrics the majority on the MPC, who continue to oppose a rate hike, are placing the greatest weight on.
The jobless rate was at the centre of the first phase of forward guidance, but as Simon Wells, economist at HSBC notes, for it to be a useful policy guide entails knowing where the MPC thinks the equilibrium, or non-inflationary rate is, and the Bank equilibrium forecasts are in a state of flux.
“The recent chopping and changing of these equilibrium unemployment rates somewhat undermines what was a key reason for focusing on unemployment,” Wells says.
Several City economists say that with the unemployment rate now at 6% and pay still weak, they expect the MPC to slightly lower its estimates of both the medium-term equilibrium unemployment rate in this Inflation Report. It was 5.5% in August and the longer-term one was a little over 5%.
When forward guidance was first launched back in August 2014 the medium term estimate was 6.5%.
Labour metrics have tightened since August. Unemployment has sped ever lower, with the rate at 6.0% now near the estimates of where the MPC had judged it would cease to weigh on inflation.
The MPC’s central estimate of the overall margin of slack was somewhere near 1% of GDP, but there were a range of views around this and members have stressed the uncertainty.
Unemployment has dropped 0.4pp since the August Inflation Report and unless estimates of the equilibrium rate are cut by as much, the jobless gap will have narrowed.
The hawks on the MPC now see risks of skidding off the 2% target if economic slack continues to disappear apace, with Ian McCafferty saying all the slack could be eaten up by the middle of next year, yet the monetary accelerator remains firmly to the floor.
With the MPC divided and McCafferty and Weale already voting for hikes Carney, who speaks on behalf of the committee at the press conference, will have another reason to be cautious in choosing his words over the timing of the first hike.
There has, however, been plenty in the recent data to embolden the dovish core of the committee. Faced with a slightly-slower-than-expected economy and quite-a-lot-slower than expected price rises, the MPC will surely peg down its forecasts for growth and near term inflation.
On growth, the MPC has long forecast the moderation in above-trend growth that appears to be materialising, but could have to revise forecasts lower still. The housing market is slower than expected. The MPC in August forecast mortgage approvals would rise to around 75,000 by end year and in September they fell to just 61,300.
The German economy and the rest of the Eurozone are also weaker than the BOE expected – although the US recovery has strengthened.
Other survey data, such as Confederation of British Industry, British Chambers of Commerce and CIPS/Markit PMIs show growth weakening further. The MPC will most likely cut its growth forecasts, of 3.5% for 2014 and 3.1% for 2015, to reflect this.
While Carney will likely steer clear of endorsing market rate expectations, however, he is also likely to avoid directly undermining them – instead leaving enough uncertainty around to provide the committee with room for manoeuvre next year.