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After a brief respite, major debt markets have continued to move towards higher yields over the past week. Much of the emphasis for this move came from much stronger than expected third-quarter GDP growth estimates released in both the US and the UK.
The US figures showed third-quarter GDP rising by 2.9%, well ahead of the median expectation of a 2.5% increase. This latest release has all but removed any doubt that the Fed will raise rates before the end of the year. Some think it might come as a result of this week’s meeting of the FOMC, but with the presidential election being imminent most forecasters expect a month’s delay. The Fed fund futures market was trading on the basis of an 80% probability of a rate hike in December on Friday immediately after the figures were released.
However, for most UK readers the news from the US was just grist to the mill given that they were still digesting the news that the first estimate of UK third-quarter GDP showed growth at 0.5%. The median forecast had been for a rise of 0.3%, but a few brave souls were going for a notch higher. The immediate post-referendum forecasts of either nil or negative GDP growth now look very misplaced. Interestingly, the Bank of England had always remained rather more optimistic, forecasting a 0.1% increase before raising that to 0.2% last month.
With GDP growth motoring away at a much higher rate than could have been expected, and with inflation moving rapidly higher and expected to move above its 2% target level by the middle of next year, this week’s MPC meeting, and the release of the Bank of England’s Quarterly Inflation Report, are eagerly awaited.
The MPC will have the benefit of being able to digest some useful economic data prior to their meeting. They are not likely to spare too much time for today’s household borrowing figures, although the news that mortgage approvals have bounced back up to 62,900 from 60,000 (a 20-month low) will be taken as encouraging. The crucial releases this week are the CIPS PMI surveys for manufacturing, out tomorrow, and the service sector, out on Thursday.
Last month the manufacturing figures were surprisingly strong and the median forecast is for a drop back from 55.4 to 54.4. However, this would still imply that the negative impact that manufacturing had on the recent GDP number is likely to be reversed in the fourth quarter. The more crucial services sector figure is not expected to show any significant change from September’s 52.6 outcome.
As if determining monetary policy weren’t difficult enough, the MPC meeting will take place amid mounting criticism of the role it is currently playing. Some of this criticism is that the bank has been working hand-in-glove with the Treasury (particularly during George Osborne’s reign) and has forfeited its reputation for independence. Others criticise it for exactly the reverse, arguing that it should come under greater scrutiny or control. Theresa May would appear to fall into the latter camp. We are notorious for often commenting unfavourably on some of the MPC’s decisions, but the decisions taken when monetary policy was determined by the Chancellor of the Exchequer were motivated by political considerations and were vastly worse. In any event, this is still a time of high uncertainty following the Brexit vote, and we are heavily dependent on overseas investment in government debt to fund the current account deficit (further enhanced by Standard & Poors’ confirmation last week of the UK’s downgrade to AA). Removing the confidence generated by having an independent central bank setting monetary policy would be the equivalent of shooting off both feet.
All of which brings us to this week’s meeting. Following last week’s GDP figures, the market has now assumed that the forward guidance given back in August by Mark Carney - that base rates would probably need to be cut again before the end of the year - will be jettisoned. Given that every piece of forward guidance that the Governor has produced during his reign has proved to be incorrect, we doubt that keeping up a 100% record for misguidance will concern him too much.
We would like to see some sort of realism from the Bank of England over the impact of QE. Judging from noises emanating from various MPC members last week, the Prime Minister’s comments in regard to QE have now instigated a need to defend its deployment. Unfortunately, none of the defence has managed to differentiate its usage in high or low-interest rate environments.
Nobody doubts that the use of QE in the aftermath of the 2008 financial crisis was very beneficial in helping to bring down medium and longer-term rates, which almost certainly assisted in bailing out many companies from insolvency. However, after several years of continued economic growth, one should not need to hammer the five-year swap rate down to below 0.50% to encourage investment. Indeed, at these levels, QE is more likely to deter investment rather than the reverse. When presenting BT’s results last week, CEO Gavin Patterson noted that the deficit in BT’s pension fund had risen to £9.5bn following the MPC’s August QE package – more than £3bn higher than a year previously. So, blame the MPC if you have dreadful broadband.
Unfortunately, the Prime Minister’s intervention is unlikely to encourage the MPC to be seen reacting to her criticism. The best one might hope for is an indication that some of the more ‘helicopter’ features might be removed. Ending the reinvestment of maturing bonds might make a start by at least getting the QE programme to be self-liquidating – albeit over a very long period.
The Bank of England is between a rock and a hard place. It is still likely to be very concerned that its expectation of a Brexit-generated economic slowdown is merely delayed rather than inaccurate. However, it can hardly ignore the relatively strong figures and will have to adjust its forecasts to reflect them. Furthermore, the Inflation Report is not likely to pretend anything other than that the UK is in for a period of rapidly increasing inflation. There is a limit to what one can ‘look through’, especially with an escalating funding requirement. The MPC cannot afford to lag behind market expectations, so we expect it, sensibly, to avoid any guidance, but to make it clear that monetary policy is at a crossroads. It is as likely to be tightened if inflation is perceived to be gaining a stronghold as it is to be loosened again should economic growth start to weaken back to their previous forecasts.
All views expressed here are the author’s own and are based on information and data available at the time of writing.
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