Posts tagged ‘Mark Carney’

Unusual Territory

Last week the UK saw an unexpected election result. This week, we had a quarterly Inflation Report out from the Bank of England which covered some unexpected ground, prompting a modest effort by Governor Carney to cover over its tracks.

The Bank surprised everyone by wading into the country’s debate on immigration. This is a pressing political issue at present, and not one which has figured in its previous reports on monetary policy. What is clear from reading the Report itself – and is blindingly obvious logic in any case – is that the high level of net inward migration into unskilled and medium-skilled employment in recent years has depressed wage growth when this is considered as an average across the workforce as a whole. During the course of a lengthy dissertation on supply side economics and the output gap it was inevitable that this would come up.

Mr Carney subsequently gave an interview to a broadcaster known for its libertarian views on border control in which he sought to play down this aspect of the report, but the following summary from the Guardian newspaper compares fairly with the contents of the Bank’s document:

[T]he MPC is deeply divided about how much slack there is in the labour market … a key sentence in the inflation report warned: “It is possible that there is more slack than in the central view. That would be consistent with weaker wage growth recently. And the potential for net inward migration could mimic the effects of slack in terms of its impact on wage pressures.”

In other words, more rapid migration may have been holding down wages.

There is little more to be said on this topic but is interesting to note a significant omission from the Bank’s discussions: the 1% cap on public sector pay introduced in 2012 and pay freeze which preceded it.

When the late coalition took office, wage growth in the private sector had been running at an annual rate of under 1% for some time (and was negative for most of 2009). On the other hand, existing mechanisms had seen public sector wages continue to rise at rates of 3.5-4%. Given the need to reduce a whopping fiscal deficit at the time this pay cap seemed fair. But now the situation has almost reversed. Private sector wage growth is running at about 2.5%: not exactly a bonanza, but princely compared to the 0.5% for the public sector.

This gap is material since public sector workers constitute over 17% of the workforce, meaning that it would account for about a third of the 1% of earnings sluggishness attributed by the Bank to labour market effects. It never gets much attention, however, because the focus is on the headline rate of earnings growth across the economy.

It would nice to think that this is why it was omitted by the Bank. As a frequent consumer of its fascinating reports, however, this blog suspects the real reason is that micro policy decisions like this do not – and to be fair, cannot – appear in the learned macroeconomic works of theory on which the PhDs who compile those reports are whetted.

What there is rather more of in the Report is anecdotal musing on the omnipotence of the central banker of today. We read in the very first section, entitled “Monetary policy and financial markets”, that the ECB is behind the rally in eurozone bonds and the strong performance of Continental equity markets (pp. 9-11). Then on p. 12 we see that the Nikkei has strengthened due to the enhanced intervention of the Bank of Japan. Indeed, amid the discourse on labour supply in Section 3 we learn that: “One factor that will affect how quickly demand responds to higher labour supply will be the response of the monetary policy maker.”

This is in line with market reality: so much trust is being placed in central banks that risk assets are very vulnerable to adverse changes in their rhetoric – never mind what might happen once monetary tightening actually becomes a reality.

To our own Bank’s credit, the Inflation Report and Mr Carney’s own guidance is reasonable. Inflation is expected to pick up again as the base effects of cheap crude fade away, rates will go up, and they probably won’t have to do so sharply though one can of course never be sure. Perhaps it is because we now accept this reality as a given – indeed as an irrelevance – that all the attention has been on what was said about job-seekers from overseas. But while markets may accept with their minds that interest rates will go up, they have not felt it happen for many years (the Bank of England last hiked in 2007). We must hope when the time comes that they will like reality as much as they have found solace in rhetoric.

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15/05/2015 at 4:50 pm

Carney Talks!

June 2014 is turning into The Month of the Central Banker. Last week it was the rock star, Mr Draghi, on stage; this week it has been our own (imported) Mr Carney. Yesterday the Governor of the Bank of England set pulses racing when he announced that the base rate, pegged at 0.5% since March 2009, could be heading higher “sooner than markets currently expect.” Never mind that the pace of rises would be “gradual and limited” – nor that there was much else of interest in yesterday’s news about Bank control of mortgage lending criteria, multi-currency facilities and broker lending too. Rates are going up! was the cry that markets took.

The pound, while off its highs for the day, strengthened materially, especially against the euro. The FTSE 100 is back down where it ended April. Short dated gilts took a hit. And market expectations for the base rate, as measured by the three-month LIBOR future, have moved higher in large volume (£234bn worth of the December 2014 contract alone at time of writing).

Yet the moves do not reflect anything like a proper panic so we should not blame Mark Carney for putting on a lousy act. And after all, he has the fundmentals behind him. The UK economy has been growing  strongly – why, we are on track this very quarter to produce the same level of output, in real terms, as we did at our peak over six years ago! And unemployment figures out on Wednesday showed the ILO survey measure down another 0.2% to 6.6%, now lower than in Germany. Pretty soon, even the Bank of England’s pie-in-the-sky inflation modelling will begin to suggest a rate hike is warranted.

There is a more interesting debate to be had, and it is this: how might we expect markets to behave once rate rises become a reality?

With equities down, bonds down, the currency stronger and the property market apparently in the Old Lady’s sights the answer may seem obvious. In any case, with those LIBOR markets now expecting the first rise to come as early as September, it is not that academic.

Doom among asset classes is but rarely universal, however. The market is now pricing for 1-1.25% of tightening in the year to September 2015. This is consistent with the 1.25% occurring from June 2006 to July 2007 and the 1% from October 2003 to August 2004. Taking a proper recession as a starting point, the pace of hikes from July 1994 to February 1995 was a little more aggressive (1.5% over that much shorter period), but policy history and inflation expectations were also different back then.

The gilt market knows all this. But it has had a good year, and might just be expecting inflation over the longer term to remain as subdued as it has been in recent months. In an environment where global activity is picking up, and the Bank of England is sufficiently worried about prices to be hiking base rate for the first time since 2007, there is surely a risk that longer-dated interest rates will have to rise alongside shorter ones.

At the same time, equity markets have generally risen as interest rates have gone up, not fallen, reflecting an alignment of future views on economic, price and earnings growth. Dislocations such as an inflation crisis or the ERM debacle and other factors can skew this logic, but the fact is that over the last 20 calendar years, the base rate has risen across seven of them, and the FTSE 100 index then fallen only twice. When rates have fallen, over eight of those years (they were flat the rest of the time), equities have also fallen twice. We should at least read into this behaviour that the direction of short term interest rates is a poor predictor of equity market performance and not, perhaps, be too concerned about today’s falls as a result.

The message is similar for the currency. The fate of the pound will also hang on what everyone else’s interest rates, growth patterns, equity markets and so on are doing: “rates up, pound up” on anything other than a highly temporary basis is not a view ever worth taking. (Over the longer term, purchasing power might be able to tell us something about the likelihood of sterling’s regaining its pre-Great Recession highs, but that is another story.)

An interesting week for observers of the UK, then, but not one which has provided much of predictive use from short term reactions. Taking a step back, we should view Mr Carney’s announcement as perfectly consistent with a strengthening economic recovery in Britain and around the world – if, of course, that is what we continue to get. There are ideas that might well give us about investment decision making, and it is in the context of such ideas which this week’s news from the Bank should be considered.

13/06/2014 at 5:07 pm

New Bod, Old Tricks

The eagerly-anticipated arrival of Mr Mark Carney as new Governor of the Bank of England apparently produced its first real news this week. Presiding over the regular release of the Bank’s quarterly Inflation Report on Wednesday, Governor Carney announced that UK interest rates will not start going up until the ILO measure of unemployment falls to 7%. This measure has not moved much over the last four years, stuck around an average of 8%, so who is to say when this might happen? But not to worry: the condition is subject to three “knockouts”, which are in fact two. If inflation looks like it might be getting troublesome, then rates might go up. And if the financial system looks like it is imploding due to the low level of interest rates – how this might occur is yet to be clarified – then a change will also be considered.

This generated some coverage, though market reaction was understandably confused. The pound rose somewhat, trade weighted sterling bouncing back to about what it averaged in June. On the other hand stocks fell, with the FTSE 100 falling by 93 points on the day. Meanwhile, gilts bobbled around a bit before finally deciding to do nothing at all.

For the benefit of readers however, this blog can state that there is one new development of note: namely, that the supposed commitment to a 2% CPI target over a 2-year forecast horizon has been effectively abandoned. Its replacement is a supposed commitment to a 2.5% CPI target over a 1.5-2 year forecast horizon (“knockout” number one).

Nobody seems to have noticed this usurpation of the Exchequer but it doesn’t matter anyway. The Bank’s inflation forecasts have been garbage for years. They have consistently underestimated CPI over their forecast period in good times and bad while doing everything they can to drive it higher.

From the volume of comment in the business pages one might find this hard to believe. But it is August, they have to have something to write about and it is true: other than this one change nothing is different. The first paragraph of all the Inflation Reports since February 2004, when CPI took the limelight from RPIX, has read along these lines:

In order to maintain price stability, the Government has set the Bank’s Monetary Policy Committee (MPC) a target for the annual inflation rate of the Consumer Prices Index of 2%. Subject to that, the MPC is also required to support the Government’s economic policy, including its objectives for growth and employment.

Mr Carney’s predecessor was explicitly prioritizing this supposedly secondary aim as far back as January 2011. The emphasis is not new. In fact even the soft target for unemployment is a poor show compared with targeting nominal GDP growth, as some had been hoping Carney would do.

In other words the Bank will carry on ignoring inflation and doing everything it can to push up activity and job numbers (beyond what it has already done: not much).

We must be fair to Mark Carney. As well as presiding over monetary policy he also has a firm to run, and has let it be known that he wants more women at the top of the Old Lady, with a view to one of them becoming Governor in the fullness of time. He is likely to be pre-empted in this ambition by the Fed if recent speculation is to be believed, but then they were the first ones to start linking monetary tightening to specific unemployment figures too so this cannot bother him.

In any event, his legacy is unlikely to be overshadowed by that of the newly-ennobled Mervyn King. All those years at the helm and the only prices he managed to contain were those of the sandwiches in the Bank’s canteen.

Whether Mr Carney manages any better on the inflationary front remains to be seen. The early signs are not encouraging.

09/08/2013 at 5:17 pm


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