Interest rate pros and cons evenly balanced

Attention has refocused on monetary policy setting in the United Kingdom recently.

This has followed a flurry of contradictory messages over the past week and a half from the Bank of England’s Monetary Policy Committee.

On June 15th it was announced that three of the Committee had voted for a rise in interest rates. This was the first time three members have voted this way since May 2011.

At 5-3, it was a fine margin, though still a narrow vote in favour of the current ultra-accommodative 0.25% rate.

Then a few days later, in his delayed Mansion House speech in the City, Governor Mark Carney said that ‘Now is not yet the time to raise interest rates’ due to Brexit uncertainty and weak wage growth.

But the very next day the Bank’s Chief Economist, Andy Haldane, who is a close working colleague of Mr Carney’s, said the exact opposite at a speech in Bradford, arguing that he would now be in favour of raising rates later in the year.

For the Chief Economist to contradict the Governor is unusual, given that executive members have tended to back their leader. There may be an element of Mr Haldane trying to position himself for the Governorship when Mr Carney retires in 2019.

It begs the question of what had changed since he voted to keep rates on Hold the week before.

It is worth mentioning that the MPC is currently under strength after the surprise resignation of Charlotte Hogg for not making sufficient disclosures before taking up her position as Deputy Governor for Markets and Banking.

Furthermore Kristin Forbes, an external member of the MPC and a ‘hawk’ who has voted for an increase at the last three meetings, is due to leave the Committee by the end of June. She is due to be replaced by Silvano Tenreyo, about whom not much is known at present.

If Haldane stays ‘hawkish’, and Silvano Tenreyo votes for an increase too, the next vote on August 3rd would be split 4-4 (assuming Ian McCafferty and Michael Saunders vote for an increase again). Mark Carney would likely vote for no change again, so this would favour the status quo (no rise), but we would come agonisingly close to the first interest rate rise since 2005.

The UK has now had negligible rates for over eight years, with the last move down, not up.

In favour of a rate rise are the following factors:

The interests of ‘normalisation’, or taking away some of the extraordinary stimulus now that the financial crisis is over; rebalancing the economy away from consumption and towards exports and manufacturing; taking some heat out of the housing market, given that house prices are way above long term averages; inflation at 2.9% is above target, and on a rising trend (with the MPC recently noting signs of domestically generated inflation and forecasting that CPI will be above 3% by the autumn).

In favour of no change are these factors:

Consumption is stalling, and the economy was weak in the first quarter (growth just 0.2%); the uncertainties of the Brexit negotiations; the scope to ‘look through’ inflation given the last burst of inflation in 2011 fizzled out and did not translate into systemic inflation; the possibility that the ‘Philips Curve’, which suggests an inevitable trade off between employment and inflation, is a bust model.

Overall, the pros and cons are evenly balanced. Given that the fundamentals don’t point decisively in one direction, it is inevitable that the voting intentions of individual members start to become more important.

Two year government bond yields have spiked up following Haldane’s comments, from a derisory 0.1% to an uninspiring 0.32%. The probability of a rate rise in November has increased to 47% from 10% earlier in June.

MPC meetings may become fractionally more interesting than they have been for several years.

James Penn
Senior Porfolio Manager

Article first appeared in:
IOM Today (5th July 2017)

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