Today has been dubbed Super Thursday, because there is a wodge of new information coming out of the Bank of England about the economy and interest rate policy. But how super will it be for the financial markets?
It is super because for the first time the Bank will be publishing the minutes of its Monetary Policy Committee meeting on the same day as the interest rate decision, the monthly press conference, and this edition of its quarterly Inflation Report. Up to now these events have been spread out over a fortnight. That of itself would give spice to the day, but given that we are in the glide-path to the first rise in interest rates since the financial crash, there is an added edge. What will we learn, not only about the timing of that first increase and the path of rates thereafter?
The background is that the economy is growing steadily. The latest take on that comes from the purchasing manager indices, which give a decent early-warning indicator of the likely rate of growth in the months ahead, published yesterday. They remain positive and suggest that growth will continue to run at 0.7-0.8 per cent a quarter, or close to 3 per cent a year. You can see the relationship between the PMIs and growth in the top graph.
That is a little above the long-run potential growth rate of the UK economy, but not alarmingly so. The RBC Capital Markets economics team that put together the graph notes that while growth is solid and employment rising, pricing pressure remains below its long-term norm. I suppose, translated into interest rate expectations, that this rate of growth could withstand an increase, but a rise is not yet essential.
Everyone expects the MPC rate “hawks” to remain in a minority so there will be no change in rates. But there will be interest in how many committee members do vote for an increase – two or more? – for that will give a feeling about the movement of rates in the months ahead. The minutes too will help in gauging how fast opinion is shifting among the members.
Timing matters because it has an immediate impact on the pound. In the bottom graph you can see what has happened to the trade-weighted index since it was rebased in 2005. We have recovered nearly three-quarters of the fall that took place in 2008, a climb that has led to a hot debate as to whether the pound is overvalued. The International Monetary Fund thinks it is, but then the IMF economics team has been haywire in its assessment of the UK economy for some time. (Remember that stuff about the Coalition “playing with fire” with its fiscal consolidation just as the economic take-off gathered speed?) A number of market commentaries from banks such as Citicorp disagree, and the market self-evidently thinks that the pound is not overvalued, at least in the short-term.
A commonsense assessment would be that while an over-strong currency does do economic damage – look at Switzerland now – we did not get much obvious benefit from the rather weak sterling from 2009 to 2013. So maybe exchange rates matter less than they used to.
At this level at least the climb of the pound does not seem to be doing too much damage, but it will be interesting to see if the Inflation Report tells us more about the Bank’s views. Its network of agents around the country, who spend their time talking to industrial and commercial companies, will also give a feeling for the pressures generated by the recovery of the pound.
The pound matters a lot because any rise in its value has the effect of tightening monetary policy. The Bank used to have a rule of thumb that a 1 percentage point change in interest rates had a similar impact to a 4-point change in the exchange rate. In other words the near 10-point rise in the pound this year has been equivalent to a 2-point rise in interest rates. The rule no longer applies, and it was always a crude calculation, but it gives some sort of feel for the fact that policy has tightened a little. Besides, there is something to be said, after such a long period of interest rate stability, for wanting to have someone else break the ice.
That someone, of course, is the Federal Reserve. By rights the Bank should take into account international events only insofar as they affect the British economy. So you worry about the mayhem in Europe not because you are concerned about the Greek catastrophe but because of what it might do to demand for our exports. You worry about China because of the impact of Chinese demand both on our exports and on global commodity prices. And so on.
The actions of the Fed, however, are a different matter. They affect global sentiment. Rates there will, we are assured, be data driven. If the economy continues to grow decently then rates will start to rise, maybe as early as the next meeting in September. If the Fed does go first, that would take a bit of pressure off sterling, but more importantly it would give the Bank covering fire for it to move UK rates. The Bank would be part of a global movement, not an outlier. So we would move at the next big quarterly meeting, the one coinciding with the next Inflation Report – we could in theory go in October, but I suspect the balance of judgement on the MPC is not ready for that.
This is not certain by any means. A lot can happen between now and November. But if you are going to have to do something there is a lot to be said for getting on with it. Inflation will bounce back once the impact of the fall in the oil price moves through the system. The main developed nations are at last getting fiscal policy back to some sort of normality. At some stage we have to get monetary policy back to normality too, for the costs of ultra-cheap money are becoming increasingly evident. Indeed, it is looking safer to move soon rather than hang about. The probability then is that the first rise in rates will come in November. Look for signals of that today.
