Taking action to rein in inflation has never been a particularly pleasant prospect for those tasked with safeguarding their state’s monetary system. But if today’s central bankers find their choices to be somewhat unpalatable, they can at least take comfort in the fact that they are not the first to face them.
Towards the end of the third century AD, a bout of high inflation was threatening the Roman economy with collapse. A rebellion in Palmyra had spread to the neighbouring country of Egypt, restricting grain supplies and causing prices to spike across the Empire. Worse, the mint workers responsible for producing the Antoninianus, a silver coin worth two denarii, had been adulterating its metal content for years, reducing the amount of silver that went into each coin and embezzling the profits. Something had to be done and, in 271 AD, the recently inaugurated Emperor Aurelian ordered the mint to repurchase all debased coins in exchange for new ones with a fixed level of silver content, and to cancel all contracts made in the ‘old’ currency. Prices fell almost overnight, but the disgruntled mint workers went into open revolt. The fighting was quelled relatively quickly, but at a cost of a reported 7,000 soldiers’ lives and the execution of the public official charged with supervising the mint. Aurelian established a reputation for ruthlessness that would serve him well abroad, but would also lead to his assassination just four years later.
The members of the Bank of England’s MPC could thus be forgiven for feeling that history has its eyes on them as they prepare to raise UK interest rates above 0.5% for the first time in over nine years. Indeed, in the face of last week’s announcement that year-on-year CPI inflation for March was only 2.3% - its lowest level since March 2017, and well below the expected figure of 2.7% - a certain degree of hesitance is understandable. But this did not make the experience of watching Mark Carney hint at yet another U-turn on his previous ‘forward guidance’ any less frustrating.
On Thursday evening, the Bank’s governor gave an interview in which he suggested that markets had gotten ahead of themselves by assuming that a rate rise in May was a foregone conclusion – a somewhat perplexing comment given that it had been his own guidance that had led them to this point over the preceding months. Both UK swap rates and sterling duly fell back from their highs, and market participants were once more left with the feeling that they had been messed around by the so-called ‘unreliable boyfriend’ making promises he couldn’t keep.
This is not remotely intended as a criticism of the Bank’s failure to forecast the future path of interest rates correctly, but as one of the governor’s increasingly strained attempts to give the impression that he can do so. It turns out that, as many predicted when Carney first embarked on his forward guidance policy in August 2013, the Bank is no better position to do this than any other forecaster – which is to say that its forecasts are scarcely more useful to borrowers than an appropriately calibrated random number generator.
From a risk management perspective, the important message to take away from all of this is that a good hedging strategy should never be determined exclusively by a market view, but instead by the degree to which it is aligned with one’s business objectives. If those responsible for setting our monetary policy are unable to predict the relevant macroeconomic factors, it is unlikely that market participants will be able to do so.
Speaking personally, it is relatively easy to envisage a tightening cycle in the UK, if for no other reason than to avoid negative spillover effects in the face of the Federal Reserve’s rate hikes. But it is also not overly difficult to imagine a continuation of easy monetary policy in sympathy with a government anxious to keep its borrowing costs down and inflate away the value of its debt. The current experiment in central bank independence may have been successful to date, but it is scarcely more than two decades old and has a value that has been openly questioned by key cabinet ministers as recently as 18 months ago. Thankfully, today’s rate setters will not face an Aurelian style revolt in response to their monetary policy decisions. But they may be keenly aware that for most of history, as in the third century, it was the emperor who took those decisions and the head of the mint whose head ended up in a basket.
Upcoming data releases
It is set to be a relatively quiet week for economic data, although we will have the following key releases:
• UK Public Sector Net Borrowing (Tuesday) – expected to have increased by £1.3bn following last month’s decrease of £0.3bn
• ECB meeting and rates announcement (Thursday) – no change expected
• Advance UK GDP growth for Q1 2018 (Friday) – expected at 1.4% YoY
• Advance US GDP growth for Q1 2018 (Friday) – expected at 2.0% (annualized) QoQ