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Mark Carney has hinted that interest rates are likely to be higher than the market expects. The market shrugged. But if the pound strengthens – as could well happen – investors could end up wrong-footed.
Being a high-profile public servant can be a humbling role sometimes.
When the boss of the Federal Reserve, America’s central bank, speaks, markets tremble.
The Fed chair, for good or for bad, can move stock and bond markets with a stray word, a careless whisper, a raise of his or her eyebrow.
Yesterday, Mark Carney, boss of the Bank of England, flat out told markets that they were wrong.
Nobody gave a hoot.
Carney speaks, the market shrugs
The Bank of England’s interest-rate setting body met yesterday. The Monetary Policy Committee was unanimous in voting to keep interest rates right where they are, at 0.75%.
But Bank boss Mark Carney was keen to put markets straight.
Right now, markets expect there to be just a single interest rate increase between now and 2021. In other words, they don’t see rates in Britain going above 1% for the foreseeable future.
Carney is not happy. He wants to flag up the risk that markets are wrong.
He points out that if the economy evolves along the lines of the Bank’s central forecast (and I’ll emphasise that these forecasts do have a wide range of outcomes attached to them), then growth and inflation will pick up over the coming two years.
And if that happens, then there’s no way that rates can stay at just 0.75% or 1% indefinitely.
Yes, this central path assumes a “smooth adjustment” to new trading relations with the EU. But given that Brexit appears to have been kicked into the long grass for the moment, there’s no obvious reason to expect anything else (other options are possible too of course, but having this as your central view is not overly optimistic).
Now, if the central banker running a currency tells you that interest rates are going to be higher than the market expects, you’d normally expect that currency to strengthen. Potentially quite sharply, in fact. So what did the pound do?
Nothing. Nada. Not a murmur in the forex markets.
As the FT points out, by late afternoon “the pound had not moved against the US dollar.” Nor had traders shifted their opinion on interest rates – “futures markets still thought the [Bank] would raise rates once… over the next three years.”
If the political upheaval fades for even a moment, the pound will strengthen
Now, you can see why markets might be inclined to dismiss Carney. Of all the world’s major central bankers, he’s proved to be the least informative. They don’t call him the “unreliable boyfriend” for nothing.
The Fed, the European Central Bank and the Bank of Japan, all tend to follow through on their views. The Bank of England has had a habit of saying one thing and doing another. And not in a clever “let’s trick the market into doing what we want” way. More in a “does any of this really matter?” way.
And to cut Carney a bit of slack for a moment, he does have Brexit to contend with on top of this. It’s very much the elephant in the room and it’s pretty hard to think about anything else having much impact on the pound until it’s closer to being resolved.
However, the thing is, this is one of those rare-ish occasions where I think Carney has a fair point.
If Brexit goes smoothly – or at least, happens at a pace the markets can handle – then chances are that the UK will need more interest rate rises. After all, if the UK had not voted to leave the EU in 2016, then I think it’s reasonable to argue that interest rates would probably be significantly higher than they are now.
In fact, Britain would probably have followed the US route more closely in the last two years. So, ironically enough, we’d probably now be talking about whether the Bank of England had raised too far and too fast, and maybe needed to look at rate cuts.
Meanwhile, whether you like to admit it or not, the UK’s economic situation – once you see past Brexit – is perfectly OK. Unemployment is at record lows. Growth might not feel spectacular, but nor is it weak enough to justify 0.75% “emergency-level” interest-rate policy either.
House prices are on the slide, but that’s not really anything to do with interest rates at the moment. Admittedly, if they were to rise, it wouldn’t help matters on that front, but prices need to fall in any case.
Equally, a rate rise would likely have less immediate effect than many might fear – so many people are now on fixed-rate mortgages that the “transmission mechanism”, whereby changes in interest rates immediately affect a large number of people’s disposable income by lowering or raising the cost of their mortgage – is probably less significant than it was back in 2008.
What does it all mean? Markets are ignoring Carney for now, and they’re probably right to. But if and when we get back on a more even political keel, expect a stronger pound.
By the way, we’ve just launched a new column with my colleague Dominic Frisby – every Friday in Currency Corner, Dominic will be taking a look at the latest news from the forex markets and looking at the most powerful currency trends. Don’t miss it – you can check out the first column here.