As expected, the Bank of England on Thursday left the asset purchase facility (APF) unchanged with a unanimous vote and kept interest rates steady, with two members (Saunders and McCafferty) dissenting in favour of a 25-basis-points rate rise.
The debate among forecasters was whether BoE chief economist Andy Haldane would vote for a rate rise to keep the split unchanged from the June meeting (5-3) after the departure of Kristen Forbes’s dissenting voice. While the analysis of the split is interesting, it is not the core driver of GBP or UK interest rates at the current juncture.
The quarterly inflation report (QIR), whose simultaneous release mad BoE's put the "super" in the BoE's "Super Thursday", brought marginal reductions to the monetary policy committee’s growth projections (cutting 2017 GDP forecast to 1.7% from 1.9% and to 1.6% in 2018 from 1.7%). It also lowered the bank's forecasts for wage growth in 2018 to 3.0% from 3.5% previously. However, in our view, this is not the core driver of GBP or UK interest rates at the current juncture either. The bank’s updated growth forecasts are still above the central market expectation.
Furthermore, the QIR analysis lowered the bank’s forecast for the potential (or trend) growth rate of the UK economy, which in turn led to the statement that, if the economy progresses in line with BoE expectations, then the bank “rate may need to rise more than markets currently imply” (as a function of above-trend growth) — currently around two 25bps rate rises over the next three years, starting in the third quarter of 2018.
However, from our perspective, the negative reaction of the GBP and UK rate markets to the "Super Thursday" news resulted specifically from the bank pointing out the negative connotations of the uncertainty of the Brexit negotiations and, in many respects, the relatively unknown direction of the talks. BoE governor Mark Carney was clear in emphasising that “growth remains sluggish in the near term”, specifically due to lower business investment due to Brexit uncertainty and its negative impact on wage growth and productivity growth.
In contrast with this negative view of the UK's near-term growth prospects, the National Institute for Economic Social Research, NIESR said earlier in the week that “Britain’s economy will surge back to life in the next six months following its slow start this year”. The NIESR said “a boom in exports after the fall in the pound and a return to bumper wage rises next year would be enough to increase GDP growth to almost 2% and convince the central bank to increase the cost of borrowing”.
“It may be the biggest problem that the modern world has ever faced… This will create a nightmare for every area of life, in every region... ” — Gary North
As firms and individuals try to understand and calibrate the implications of Brexit, it is perhaps increasingly important that the government play a role in reducing uncertainty and countering fear wherever possible. The above quote, from The Economist, perhaps sums up the potential for negativity of uncertainty. The author of the quote, however, was not fearful of Brexit, but of the "Millennium bug"!
The key point here is that the main destabiliser to business investment, and therefore the UK economy, is the uncertainty that the government has generated in its negotiations, strategy, and communication. The "marketing" of the Brexit plan has been nothing short of shambolic, and it has led to a cautionary delay in business investment that has, in turn, weakened the government position and promoted a fear that exaggerates the negative and ignores the positive. Perhaps the PM needs new PR?
“It wasn't a lie, it was ineptitude with insufficient cover” — Don Draper, Mad Men
On a wider note, the political shenanigans in the US are becoming increasingly audible, as is the concern in financial markets, with one notable outlier. Over recent months, the inadequacies of the Trump administration have eradicated expectations of US fiscal stimulus from growth and inflation forecasts, which has lowered interest rate expectations (flattening the curve) and dented the USD. In recent weeks, political worries have grown further, culminating in last night’s announcement that US special counsel Robert Mueller will impanel a grand jury in Washington as part of the Russia probe.
Ironically, the exception to the heightened concern (and indeed volatility) is the US equity market. It is likely that the USD's slide is helping global profits. There is a point, however, where the political backdrop becomes sufficiently weak or uncertain to undermine the stock market. It seems, however, we are not there yet.
From the perspective of the USD, we are increasingly convinced that the prospects of a capitulative selloff in the USD are rising, and failure to find strength in some aspect of this afternoon’s US employment report could be the trigger.
The shenanigans in Washington could be entering a new phase. Photo: Shutterstock
— Edited by John Acher