A Matter Of Timing

15/07/2016 at 4:10 pm

We are now more than half way through 2016. As the year dawned this blog identified monetary policy and the oil price as two of the key things to watch. This week it was the turn of the Bank of England to set tongues wagging on the monetary front; in the meantime the oil price, which has done some central banks such a favour in recent years, has stabilized in the $45-50 range following its strongest quarterly rise for seven years.

The Bank had been expected to cut policy yesterday (from 0.5% to 0.25%). A Brexit loosening to buoy confidence had been the thinking behind this consensus. The MPC, however, held steady. Admittedly the consensus was not especially strong: of the 54 estimates collated by Bloomberg 25 had been for a 25bp cut, 6 for larger cuts and the remaining 23 (who won the bet) for no change. Nor was the defeat especially hard. The MPC announced that “most members of the Committee expect monetary policy to be loosened in August”, further noting that the “precise size and nature of any stimulatory measures will be determined during the August forecast and Inflation Report round.”

If, in the words of one senior figure on Threadneedle Street, the British economy needs a post-referendum “sledgehammer” (not an obvious choice of metaphor for a stimulus but one catches his drift), then why delay? If the Bank is to bolster confidence why didn’t it just get on with it? What sort of doctor decides that his patient, suffering some obvious ailment, could really do with a shot in the arm – but then decide to wait another month before administering it?

On the other hand, as that senior figure – MPC member Andy Haldane, the Bank’s chief economist – further put it, while there is some evidence of weakness in hiring and investment: “There is no sense of slash and burn. But there is a strong sense of trim and singe.”

In any event the point is that we do not yet know what the impact of the Brexit vote has been. There is anecdotal evidence from the property market, for instance. But it won’t be until at least early August that we have much actual data to look at.

There is an irregular exception which we ought to deal with quickly. GfK, who produce the UK consumer confidence series, undertook a one-off bonus survey in the aftermath of the referendum. (Their regular end-June number was based on surveys conducted during the first two weeks of the month.) Published last Friday this showed a fall in the index from -1 to -9, the biggest monthly decline since December 1994. On the other hand, the index has averaged precisely -9 over the last 30 years, peaked at only +7 in mid-2015 and went as low as -39 at the nadir of the Great Recession.

One thing we do know for a fact, however, is that the pound is 7% weaker, trade weighted, than it was when the last Inflation Report was published in May. It is down 11.5% in 2016 to date and has fallen 13% since its peak just under one year ago. Currency weakness is itself a form of monetary loosening which translates into imported inflation, higher exports and (not allowing for Brexit fears) greater inward investment. Is a cut of 25bp on the base rate really required as well? Particularly as the urgency of such a move is clearly not great enough to obviate the delay associated with data releases as well as the elegance of wanting to time MPC action to coincide with the publication of the Bank’s own detailed economic and monetary analysis?

And so back to oil. This is now back at exactly the level it settled at for a few months from last August. Very soon, then, the deflationary effect it has over the previous year will reduce to about zero. In February the Bank put the contribution of cheap oil to annual CPI at -0.4% through direct effects alone. That is quite a lot of disinflation to be giving up. The next RPI and CPI prints come out on Monday, with figures for July only arriving until after the next MPC meeting. So they may not be sufficient to challenge what will doubtless be a 100% consensus, backed by the MPC’s own words, for a 25bp cut next time. But the direction of travel is clear.

There is also the labour market to consider: 186,000 jobs were created during the first quarter of this year, and the ILO unemployment rate at 5% is only 0.3% off its 2004 low. Brexit risks may argue for a rate cut (though again, on that basis: why wait?) But the pound, the oil price and the labour market argue at least for staying put in August too.

The complication for investors here is that markets were already mildly disappointed with the Bank’s failure to cut yesterday. Put it off again, or postpone it indefinitely, and their disappointment may lose that mildness.

There is another possibility to consider: that Brexit fears might recede in coming months. What then for prices? And for monetary policy? And for bond markets, with the UK base rate not priced to rise above its current level until the end of 2020?

As so often our central bank finds itself in a bit of a spot. Nervousness pushes its hand one way; known fundamentals to date, at least, another. If the data which comes out between now and the next MPC meeting is unhelpful to the consensus the Bank can either act inappropriately or spook the market. If the data is poor, and so helps the post-referendum blues argument, then that is bad news for the economy.

Whatever the longer-term consequences of Brexit for the UK the shorter term prognosis for assets of certain types does not look rosy.



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