Let’s start with the facts.
- Yesterday saw the release of the Bank of England’s latest quarterly Inflation Report.
- For the second time, its growth forecast for 2017 was revised up. This now stands at 2% as against the 0.8% forecast in the wake of the EU referendum result, which the Bank officially and Mark Carney personally expected to usher in immediate economic disaster.
- Projected unemployment now stands at 5.0%, up from a 2017 forecast of 5.5% last August.
- Despite this the CPI forecast for this year has been trimmed back: to 2.7% down from 2.8% back in November.
- The “equilibrium unemployment rate” [a.k.a. the “natural unemployment rate”, a.k.a. the “non accelerating inflation rate of unemployment” (NAIRU)] has been revised down from 5% to “around” 4.5%.
- Despite its lower CPI forecast the Bank’s sub-trend growth forecast for the years following this one (+1.6% for both 2018 and 2019) is predicated on squeezed real wages under pressure from higher inflation.
Governor Carney took considerable pains to wipe the egg off his face by way of his opening remarks to the press conference yesterday. He admitted, obliquely, that consumer behaviour has not remotely suffered in the way which the Bank assumed it would last summer. But this was dismissed as the least important reason for the higher growth outlook, behind the Autumn Statement, improvements in economic confidence abroad and supportive financial conditions. Be that as it may, Mr Carney’s insouciant defence of his institution’s forecasting record does speak of a certain strength of character and for that at least he may perhaps be applauded.
The fact remains, however, that monetary conditions are still set firmly in emergency mode at a time when inflation is projected to exceed the notional target, the economy is close to full employment and growth is nudging trend. From its rhetoric, however, the Bank is wedded to accommodating unspecified and unquantifiable risks surrounding Brexit and seems intent on keeping policy unchanged for the foreseeable future.
This already looked curious last summer. Today it seems downright insane.
Now to the conspiracy.
Britain is no stranger to having her financial affairs managed on the basis of seeming insanity. Back in 1999 Gordon Brown infamously sold a large amount of the country’s gold reserves in an auction process which he announced publicly in advance. This secured him a bargain basement price for the sale. Gold subsequently multiplied in value and the period was dubbed the “Brown bottom” as a result.
The official explanation for the sale was that it would rebalance the country’s foreign exchange reserves away from a volatile commodity and into thrusting new assets such as euros. Gossip emerged later, however, that at least one major bank, likely JP Morgan, had been shorting gold to fund asset purchases in some size – a classic “carry trade” – and was threatened with serious difficulties should the price rise. Brown’s actions were therefore explicable as being for the greater good of the financial sector: there was method in the madness.
A similar case could be made today. The Brexit vote set sterling on a downward trend which persisted into the autumn. Last year’s foreign asset returns, in sterling terms, were astronomically higher than long run expected rates. And with interest rates near zero the pound is very cheap to borrow. (Remember too that it is one of the world’s reserve currencies and extremely liquid.)
Last year, then, the sterling carry trade was one of the deals of the century. As with the gold carry trade in the 90s, however, if the price of the borrowed asset goes up it doesn’t look very good for the borrowers. A rise in the value of the pound due to changing expectations for interest rates could well pose a risk to one or more banks assessable by a Bank of England Governor as systemic.
Surely it would be absurd to think that the MPC was secretly conspiring to hold down the value of sterling? Well – probably. But its official position appears no less absurd. It is also worth noting that the one key reaction to yesterday’s release and Mark Carney’s comments was a fall in the value of the pound. (Sterling had gone up as high as $1.27 in the morning, then crashed down towards $1.25 again over the course of the day.) The Bank’s forecast for the exchange rate is of near-complete stability at the current level into 2019 – or should that read, “the Bank’s target”?
It is an intriguing possibility. But this blog cannot go in for tin foil hats. So let us conclude simply by repeating the observation that the Bank’s current stance is extraordinary, and, apparently, inexplicable.