Has the BoE Positioned Cable to Make Further Gains with a Steeper Policy Outlook?The policy paths of the BoE and the Fed now appear to be diverging.
Looking ahead, cable looks on course to make further gains
Readers will recall that in early May the question was raised here of the UK’s path back to monetary policy normalisation being too slow and too shallow. In the space of under one week the Monetary Policy Committee (MPC) appears to have addressed that question, external member Gertjan Vlieghe suggesting the Committee is moving away from its ultra-dovish position towards a more neutral stance, and Deputy Governor Ramsden saying it will be vigilant in responding to inflationary threats.
Both messages have suggested a UK recovery proving stronger than anticipated, potentially necessitating a more robust monetary response. So what has changed since the May MPC meeting, when the dovish stance was repeated, to make it change tack now?
What is driving this shift in policy stance?
The shift in stance is almost certainly predicated on the strong rebound in UK activity ensuing this year – the BoE itself upgraded its 2021 growth forecast from 5% to 7.5% – and being reflected not only in stronger GDP but also in higher CPI and lower unemployment numbers. Until now the MPC has largely focused on the latter as the key factor in determining how quickly monetary policy might return to a neutral stance, labour market slack seen as sufficient to ensure emerging inflationary pressures remain ‘transitory’.
But this ‘slack’ has so far been smaller than anticipated, the Government’s furlough scheme credited with saving jobs, and even though the BoE’s most recent forecast shows unemployment rising from 4.8% to 5.4% once the scheme finishes end-September, the labour market recovery to date suggests unemployment could instead continue falling. This will provide an unexpected extra boost to demand with the potential to pull inflation higher. This is the concern of Vlieghe.
Ramsden’s comments suggest nervousness over inflation. If households spend more of their excess savings than anticipated (the BoE forecasts 10% spent over the next three years; it is not unrealistic to think it will be higher) demand will be boosted further, and data so far suggests the UK propensity to spend is high. The savings stock was estimated at £163bn, or 7.7% GDP, at end-March. BoE/NMG data suggests the proportion of savers planning to spend some of this excess has risen from 10% in Q3 2020 to 28% in Q1 2021.
Factoring in that the services sector remains yet to fully re-open, then the potential for aggregate consumption to increase further appears significant. Ramsden may be flagging the MPC is starting to worry about this, beginning to see what they labelled as ‘transitory’ inflation becoming more ‘sustained’.
Finally, it is not inconceivable that the BoE has underestimated the damage done by the pandemic to potential supply. In May it forecast output would recover to within about 1.25% of its pre-pandemic level, an improvement on February’s forecast of 1.75%. But if this proves to be too optimistic then further fuel will be added to the inflation fire.
The message from the MPC remains that policy will not be tightened until clear evidence is seen of the output gap being eliminated and the 2% inflation target placed on a sustainable footing. There is no suggestion it is moving to abandon these yardsticks. But with Vlieghe warning a stronger labour market could deliver a faster monetary response, and Ramsden suggesting growing apprehension over rising CPI, possibly there are concerns that the “clear evidence” needed could be seen in Q1, with the potential to see a first interest rate rise delivered soon afterwards.
Is the MPC trying to position itself more closely with market thinking?
The MPC is in good company in acknowledging a stronger UK recovery. The FTSE 100-share index has gained some 7.3% over the past three months, while the steady re-opening of the UK from lockdown restrictions has seen the anticipated consumer-led recovery begin to materialise. April’s retail sales figures showed monthly volumes already exceeding their 2019 average while high-frequency data is showing consumers both spending and eating into their excess savings.
But consensus with the markets has not be as strong when recognising the potential inflationary consequences of this strong recovery. The MPC has been seen as behind the ‘policy curve’ with its fixation on ‘transitory’ inflation, seeing yields rise this year as the market has imposed its own financial tightening. Perhaps the MPC is now trying to reposition itself more closely with the market, especially given the departure of the BoE’s Chief Economist, Andy Haldane, the arch-hawk who was seen as most closely in tune with market thinking.
What are the implications for cable?
It is not a great leap of faith to conclude that the next move in interest rates will be upwards, the prospect of negative rates now fully removed. This should be cable supportive. But beyond this, and possibly of even more importance to cable going forward, is that the policy paths of the BoE and the Fed now appear to be diverging.
In less than one week the MPC has acknowledged the possibility of a stronger labour market recovery, sustainable inflationary pressures, and the potential for interest rates to be raised sooner. In contrast, the FOMC continues to emphasise an ultra-loose stance that will remain in place for the foreseeable future, despite the positive data emerging. Going forward, cable looks on course to make further gains.
Opinion editorial by Stuart Cole, Head Macro Economist at Equiti Capital
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