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BMO GAM - Lower for longer remains the name of the game

Friday, August 04, 2017

BMO GAM - Lower for longer remains the name of the game

Steven Bell, Chief Economist at BMO Global Asset Management provides his reaction to the Bank of England meeting today.

The markets had been nervously anticipating the outcome of today’s meeting of the Bank of England’s monetary Policy Committee. The last meeting in June saw three members vote for a hike. All three were external members, one of whom, Kristen Forbes has since left and many noted that the other five members are all Bank of England insiders who tended to vote as bloc under Governor Mark Carney. This all changed when Andy Haldane, the Bank of England’s chief economist and traditionally a dove, indicated in a speech last month that he too might vote for a hike. 

This hawkish stance has surprised many economists who note that UK economic data has been notably soft of late and although inflation has risen sharply, this can be clearly traced to the impact of sterling weakness. The Bank of England has made it clear that they are happy to look through one-off effects such as this. Moreover, the latest set of consumer price data come in significantly below market expectation and sterling has stabilised on the currency markets.

With a new member, Silvana Tenreyo, joining the committee and the views of Andy Haldane apparently undergoing a change, uncertainty was high. Markets were caught off guard by the 5:3 vote at the June meeting (it had been was 7:1 in May) and by Haldane’s apparent volte face. Only two out of 54 forecasters surveyed by Bloomberg expected a rate hike and the market’s implied probability of a hike was only 10% according to Bloomberg in the minutes before the announcement (though this had been as high as 25% in early July). But the response of sterling to the announcement indicated that many traders were reluctant to place much confidence in the consensus view of the MPC’s actions.

The announcement, when it came, was in line with the consensus with no change in rates. But it was at the dovish end of the spectrum of possible outcomes: the vote was 6:2 and the minutes were generally seen to be dovish. The Bank of England cut its forecasts for growth and wage inflation. The one mildly hawkish move was the announcement that the Term Funding Scheme, introduced a year ago in the aftermath of the Brexit referendum will not be extended beyond next February. This will have the effect of raising the cost of borrowing slightly.

As a result, the immediate impact was to weaken sterling which fell by a 0.5% against both the US dollar and the euro. The FTSE 100 index, whose members generate most of their revenues in foreign currencies, rose in response by one-third of a percent.  Yields on 10 year gilts fell by 5 basis points.

Where do we go from here? With consumers’ suffering a squeeze on real income, the housing market weak and businesses reluctant to invest in the face of Brexit uncertainty, the UK is unlikely to see growth pick up for some time. Inflation is high only because of sterling’s near-20% decline since the end of 2015. So the case for rate hike over the balance of this year looks weak. If consumer incomes start to rise again next year and signs of domestically-generated inflation begin to emerge, the MPC might begin cautiously to raise rates. But lower for longer remains the name of the game.

One area that has received relatively little discussion relates to the Bank of England’s balance sheet which has been inflated to the tune of almost £450bn by their Asset Purchase Programme. This has the effect of depressing yields on longer dated UK government securities, gilts. Yields are now so low that deficits on final salary pension funds have been ballooning. It is high time that the MPC start shrinking their balance sheet. Yet the committee voted unanimously to maintain it.

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