The pound has been hit by yet another speech from a member of the Bank of England’s Monetary Policy Committee. Today it was BoE’s. chief Economist Andy Haldane, noting that risks of prolonged slowdown inflation may force policy makers to be prepared to cut interest rates further if needed. Haldane said inflation risks “skewed to the downside” and that inflation expectations by households may no longer be consistent with the BoE’s 2% target.
Particularly dovish from Haldane was the indication that “…chances of a rate rise or cut are broadly evenly balanced”, a statement which sheds doubts on the validity of most economists’ expectations that the next rate hike will occur between Q4 2015 and Q1 2016. Said differently, most economists are certain the next change in rates is up.
Haldane’s case for easing
Haldane expounded on Weale’s comments from last week, adding that low inflation is caused by one-off global factors such as falling oil prices, but could also be exacerbated by lingering spare capacity and a strong pound, which could effectively import deflation.
“Even without any asymmetry in risks to the inflation outlook, a case can be made for policy easing today”. “Were downside risks to inflation to materialize, this case is strengthened.”
Last week Martin Weale said inflationary shocks were rarely one-off, raising the question “whether a rising exchange rate might be the next of these shocks”, while indicating that the appreciating pound could weigh on exports until feeding into price pipelines. Those were rather dovish remarks by the MPC member who voted to raise interest rates from August to December along with fellow hawk Ian McCafferty.
Both changed their mind in January as plummeting oil prices fed through the pipeline.
Last week, BOE governor Carney reiterated it “may be appropriate to take into account persistent external deflationary forces”, which include “…the combination of continued, foreign low inflation and the protracted effects of sterling’s strength on the prices facing U.K. consumers.”
BoE members with a hawkish slant have held that any acceleration in wage growth over the next few months would strengthen the case for a rate hike, especially if productivity remained muted. The importance of earnings growth is highlighted by the fact that Wednesday’s jobs figures broke down sterling as earnings growth slowed to 1.6% in the three months ending in January after a rise of 1.7% and 1.8% in the prior two months.
BoE officials have been increasingly focusing on the disinflationary dangers of a strengthening currency, resulting from the pound’s leaping to 8-year highs against the euro. Such stepped up rhetoric from the BoE must be a pre-emptive move against further euro declines. Haldane said “monetary policy could be eased further” if the “UK will join those countries facing temporary deflation this year”.
Pound’s trade-weighed index vs. inflation
As the chart shows below, the deviation between the rise in the sterling’s trade-weighted index (with substantial weighing of euro) and the decline in GBPUSD reflects the impact of the weak euro in exporting disinflation to the UK. In each of the three cases (circled in chart) when GBP advanced markedly vs the euro or Deutsche mark, a period of low UK inflation usually followed. The current sharp deviation between plummeting GBPUSD and soaring TWI is a manifestation of the plunging euro. If EURGBP remains below 0.75 and Brent prices fail to regain $60, then we should expect more GBP jawboning from the BoE and bid goodbye to any talk of a rate hike.
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