Last week the Bank of Canada raised interest rates for the second meeting in succession surprising a lot of people in the markets who expected them to wait a little longer before acting.
Stephen Poloz, Canada’s successor to our own central bank governor, Mark Carney, proved that being a Canadian is no barrier to reacting to concerns about rising house prices, even if inflationary pressure is subdued. In Canada’s favour their economy is growing quite nicely with the latest estimates suggesting an annualised 4.5% growth for Q2, putting aside concerns about NAFTA renegotiation and a weaker US dollar which has seen the Canadian dollar rise 10% since May.
While last week’s actions were a surprise in terms of timing, they weren’t in terms of what the market was expecting given recent guidance from the central bank which had been quite clear that central bank officials were considering action on rates and as such markets should prepare for such an eventuality.
There is a lesson here for our own Bank of England as we look ahead to some important economic data of our own this week and this week’s rate meeting.
Over the course of his tenure Mark Carney has proved himself particularly unreliable when it comes to managing market expectations since he became governor in 2013. As a result markets have increasingly turned a deaf ear to anything he says.
In a sense he has turned into the central bank equivalent of the little boy who cried wolf and this is no better illustrated at the market reaction to a paragraph in last month’s inflation report, which suggested that traders were under-pricing the prospect that monetary policy might need to be tightened by a somewhat greater extent. Traders ignored it.
The seeds were sown back in August 2013, when Carney said that the Bank would not consider raising interest rates until the unemployment rate was below 7%, and that this could take three years and the creation of 750k jobs. At the time the rate was at 7.8%, and fell below 7% within a year dropping below 6% by the end of 2014.
Nothing happened on the rate front then and the chance to push rates higher was gone, and helps explain why currency traders have developed a tin ear to the Bank of England’s announcements.
This is not a good situation to be given that the European Central Bank look set to rein back their own stimulus program by the beginning of next year, and the next move in rates for other central banks while delayed, is still being priced in for a move higher.
No such head room is being priced in for UK rates, despite today’s inflation numbers which showed an increase in CPI to 2.9%, while factory gate prices also increased for the first time in six months to 7.6%.
This perception on the part of markets could well act as a significant drag on expectations for gains in the value of the pound, and could drag it lower if other central banks retain their tightening bias. This in turn could exacerbate the stickiness of current inflationary pressure, which this week’s data, is unlikely to change if markets retain their current scepticism about the Bank of England’s supposed hawkishness.
The ultimate irony from today’s inflation numbers is that last month’s push higher in CPI came about as a direct result of last year’s 25 basis point rate cut and extra stimulus. Talk about shooting yourself in the foot. So much for the banks much vaunted forward guidance!
One thing is likely, today’s data will increase the intensity of the debate between the hawks and the doves on the MPC as calls grow to reverse last year’s rate cut.
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