Was BoE Super Thursday really that dovish? Has MPC transparency really improved?

Today’s BoE data deluge has been interpreted by the market as a dovish event – GBPUSD declined 0.7% and 10 year gilts fell 6 basis points i.e. not huge moves, as per my preview. The market seems to have focussed on Weale’s surprising unchanged vote was (he’ll hopefully fill us in in a forthcoming speech, perhaps it’s because he’s not convinced that Greek tensions are finished?), Carney’s data-dependency argument and the downgrade to the short-term inflation forecast. But several arguments provide food for thought on whether the market has over-reacted.

First, Weale will undoubtedly still be voting for rate hikes in the next few months, probably by year-end i.e. well before the market expectation of an April rate hike before today’s events. Of course, some market participants seem to have held out a chance of a November rate hike (as they heard Carney’s “around the turn of this year” but over-interpreted his “likely come into sharper relief”) and there can be signalling aspects.

Second, Carney’s comment that the timing of the first rate hike is data dependent is unsurprising. As I noted in my preview he’s just following the Fed and reverting to more standard central banking after period of forward guidance (while still stressing that rate rises will be gradual and limited).

Third, the downgrade to the near-term inflation projection (due to lower oil prices and sterling’s rise) is pretty irrelevant for monetary policy: monetary policy transmission lags mean that the two and three year projections are where the action is. As an aside the 2015 Q4 modal forecast falling by 0.3pp to 0.4% sounds more dramatic if you phrase it as “inflation forecast has been halved”.

Fourth, MPC have actually downgraded their assumption on exchange rate pass through into inflation: “MPC judges that the earlier appreciation will be associated with somewhat less of a fall in import prices than previously assumed”. So they should be more relaxed about GBP strength – inflation is what they ultimately care about – whereas Carney’s speech suggested the opposite could be brewing (see my preview). That said, they’ve added a new near-term downside risk to inflation in case the new assumption proves wrong and did note that GBP strength would hold back exports (although Euro Area activity prospects will tend to be more important here, where they’ve become more negative).

Fifth, they continue to see higher wages (unit labour costs) counterbalancing sterling’s drag on inflation – and the effects of a tighter labour market should tend to be more persistent than the price level effects of GBP strength (in my view). Moreover, in the press conference both Carney and Broadbent sounded less concerned about the recent slowdown in employment growth than implied by the minutes (they seemed quite dismissive of questions). So they continue to forecast labour market tightening supporting earnings growth and even stronger that previously assumed consumption (not a debt-fuelled bubble, since the further savings ratio fall is driven by lower precautionary savings). Alongside upwardly-revised profiles for both business and housing investment this means that private domestic demand growth is expected to remain robust. So the ½% of GDP spare capacity is eliminated inside a year.

Sixth, and probably most importantly, Carney mentioned several times that the three year inflation forecast is above target and that inflation would continue rising further above target based upon the current market rate curve. And when a journalist asked whether this meant that he thought that the market rate curve needed to rise he confirmed that interpretation. In other words, Carney seems to have moved away from endorsing the yield curve to trying to encourage a steepening (which would support GBP). So it’s surprising that market pricing seems to have done the reverse.

Has MPC transparency really improved (a moan at the margins)?

My concern here is that the drafting of the MPC minutes policy discussion section means that we have become less well informed about how many MPC members are tempted to follow McCafferty in voting for rate rises.

Specifically, previous minutes used the expression “decision was finely balanced” to signify this. And the July minutes increased this to “a number of members” (if Greek uncertainties weren’t present) from the previous “two members”. Now we have the text “Some members saw upside risks to the inflation forecast” followed in the next paragraph by “For one member, these risks to the medium-term inflation outlook were now, on balance, sufficiently on the upside to justify an immediate increase in Bank Rate”. But the “finely balanced” language has disappeared. As a result we really don’t know whether: (i) “some members” is more or less than “a number of members”; (ii) whether the non-McCafferty “some members” thought that the decision was “finely balanced” or not. So whereas we previously knew that at least three members were close to raising rates we can’t be sure how that situation has evolved. That could have easily been clarified by adding a sentence “for x members the decision was finely balanced” with x equalling either “two” or “a number of” as appropriate.

This is a little disappointing, given that Carney stressed that the procedural changes were all about increasing transparency (and I generally agree that this is a great improvement). But then again you’ve got to admire BoE staff for pulling things together so well in such a short space of time.


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