Thursday, 23 January 2014

Is this a rate rise I see before me? (Part II)

I don't know if Canadian Mark Carney brushed up his Shakespeare last year en-route to the top banking job in the land of the Bard but, if he did, a line from Macbeth might prove invaluable over the next few months. If it were done when ’tis done, then ’twere well it were done quickly. Such a conundrum must now be facing Carney and his fellow Monetary Policy Committee members as they weigh up when to raise rates for the first time since hitting their all time low of half a percent in 2009.

Of course, Carney is only one member of the MPC, but he was fully responsible for the policy of "forward guidance" which he imported from the same role at the Bank of Canada. This made an unemployment rate falling to 7% the highest profile (but not only) criterion for a hike in rates. When introduced in the August Inflation Report the committee envisaged this most likely occurring in 2016.

That now looks pessimistic in the extreme. The rate hit 7.1% in Wednesday's Labour statistics, covering September - November, down a pretty staggering 0.5% compared with the three previous months. It looks set to drop below the magic number in the next month or so.

That led to what looked like Olympic record back-tracking in the same day's MPC Minutes: "Members saw no immediate need to raise Bank Rate even if the 7% threshold were to be reached in the near future", with this changed stance supported by inflation falling to 2.1% in November (funnily enough the key measure the MPC used to base rates decisions on).

Carney yesterday completed the pirouette near the slopes of Davos, at the World Economic Forum, when he told the BBC's Jeremy Paxman that he was against "unnecessarily focusing on one indicator in the future" and that there was "no immediate need to increase interest rates". 

The MPC Minutes may have argued that it was in no hurry to tighten; the markets begged to differ. Sterling rose half a cent to a three year high of just under $1.66 on the day of the employment release, while Gilt yields edged up 5 "bips" to 2.89%. Despite Carney's Newsnight comments, regurgitated today on the front of the FT, the pound strengthened further to $1.6656.

The problem facing Carney and his colleagues is Britain is very much in a twin track economy, with, for instance, house prices and car sales soaring and unemployment is plunging,  but yesterday's release showing wage growth of 0.9% less than half the rate of inflation.

However Carney defines "immediate", rates rise will have to come sooner or later, but he and the MPC, like other regulators around the globe, appear to be loathe to make the first move. It will be a rude shock to an economy and population inured to virtually zero interest rates. (Especially those lured into buying potentially over-priced new homes under Help to Buy, but facing ratcheting-up equity loan fees on top of underlying borrowing costs.)

In the meantime, a particular bug bear for Carney judging from several of his pronouncements is the rapid recovery in house prices and (reading through the lines) his concerns about Help to Buy. Before a rates rise expect some hands on intervention, either through tighter lending criteria for banks (Switzerland's doubling yesterday of the capital banks are required to hold against mortgage lending cannot have missed the attention of Carney at Davos) or pressure on government to modify Help to Buy.

But a rates rise will still happen and nobody now appears to expect to wait until 2016. The question is this year or next? Independent as the MPC supposedly is, it can never be completely immune from politics. Would Carney want to be seen to preside over a rates rise either, let's say, three months before a General Election (in May 2015) or, possibly more contentiously, three months after?

If history is to be believed, unions will be girding their loins for a push on earnings - possibly the new but less explicit guide for the MPC - as an election looms.

Citi yesterday brought forward its expectation of a hike from Q2 2015 to the final quarter of this year.

I wouldn't be surprised if, despite their sanguine public pronouncements, members are privately agonising over an earlier move. As Hamlet might have mused, were he studying economics at Wittenberg, "Q3 or not Q3, that is the question ..."

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