The Bank of England speaks like a hawk. It acts like a dove.
Those in the City expecting the Old Lady to do what it has not done for a decade – raise interest rates – would have been brought up short by the latest decision of its monetary policy committee. At 6-2 for borrowing costs to remain at 0.25%, the vote wasn’t even close.
The lack of action was accompanied by some macho talk. If the economy performs as the Bank expects, rates will go up more sharply than the financial markets currently expect. Traders think the first tightening of policy since the summer of 2007 will take place in the middle of next year; the MPC is signalling that it could be sooner than that.
There is a reason for this approach. By encouraging speculation that a rate hike is just around the corner, the Bank is trying to talk up the value of sterling. A stronger pound makes imports cheaper and so bears down on the cost of living. The Bank effectively gets lower inflation by virtue of a stronger exchange rate. It can dangle out the prospect of a rate rise without ever having to deliver one.
But will the markets really be convinced? The Bank’s assumption is that unemployment is at a level – 4.5% – where wage growth has to accelerate. Its problem is that it has been saying this for quite a long time. It expected wage inflation to pick up when the jobless rate fell through 7%, 6% and 5% and it never did. The Bank’s estimate – contained in its central projection for the economy – is that earnings growth will rise from 2% this year to 3% in 2018 and 3.25% in 2019.
At some point, workers will be able to exploit a tighter labour market to bid up wages, but there is not much to suggest that point has been reached. As the minutes of the MPC meeting noted, “there was not yet evidence of the sustained pick up [in wage growth] incorporated in the central projection”.
That is perhaps unsurprising given both the weak state of the economy and the precarious nature of the labour market. Threadneedle Street’s continued failure to understand the link between unemployment and wages means it is quite likely that when the next inflation report comes out in November the message will be the same: no rate rise but the promise of an imminent get-tough approach.
This is all very well, but history suggests that talking up the value of a currency only works for so long. Eventually, markets will decide that the Bank is all gong and no dinner. And the pound will fall unless they are tossed some raw meat.
Wall Street’s thriving, main street not so much
We’ll always have Paris, Humphrey Bogart says at the end of Casablanca as he tells Ingrid Bergman he is not getting on the plane to Lisbon with her. As the Dow Jones industrial average climbs higher and higher, Donald Trump seems to be taking a similar approach: never mind the comings and goings in a chaotic White House, we’ll always have the Dow.
Wall Street has certainly been going gangbusters. It is up by about a fifth since the presidential election last November. The Dow Jones industrial average burst through the 20,000 level in January, took only a further 35 days to get to 21,000 and this week climbed above 22,000 for the first time.
There is, though, not much correlation between the performance of the Dow and the performance of the US economy. Wall Street is thriving; main street is not. Growth is tepid, inflationary pressure is weak, wage pressure is nowhere to be seen.
So why has the Dow been doing so well? One factor has been Wall Street’s expectation that Trump will deliver on a package of corporate and personal tax cuts heavily weighted in favour of the already well-off. It might have been thought that the president’s rebuff by Congress over the repeal of Barack Obama’s affordable healthcare legislation would have raised doubts on Wall Street about Trump’s ability to deliver on his fiscal pledges. Not so, it appears.
The stock market has also been driven higher by corporations buying back their own shares. Put simply, companies have been able to borrow money because of the Federal Reserve’s post-financial crisis decision to make credit cheap and readily available through ultra-low interest rates and quantitative easing. The price of a booming stock market is that companies are loaded down with debt.
Trump was elected because a divide had opened up between America’s elite and those in poorer areas who thought they had been forgotten. The irony is that the president is delivering for the rich but not for working people, and seems oblivious to the risk of a stock market crash as reality sets in. If he thinks this is the start of a beautiful friendship he is mistaken.
