Bank of Eng­land plays a clever game

Bank sup­ports ster­ling while de­fer­ring ac­tion to cool in­fla­tion

The Irish Times - Business - - AGENDA - Eoin Burke Kennedy Anal­y­sis

In the post-crash world, cen­tral bankers pre­fer to tele­graph in­ter­est rate changes, some­times months in ad­vance so as to avoid whip­ping up greater mar­ket volatil­ity.

The down­side of this new sys­tem of “for­ward guid­ance”, for cur­rency an­a­lysts, has been a vir­tual scram­bling to make sense of the com­ments that ac­com­pany rate an­nounce­ments: whether they are more or less hawk­ish than last time; or whether the em­pha­sis on a cer­tain is­sue has changed.

The Bank of Eng­land clev­erly ex­ploited this yes­ter­day. While keep­ing UK rates at an his­toric low of 0.25 per cent but sound­ing more hawk­ish on the pos­si­bil­ity of a fu­ture rate hike, it man­aged to si­mul­ta­ne­ously sup­port ster­ling while de­fer­ring more de­ci­sive ac­tion to cool in­fla­tion, now run­ning at 2.9 per cent, un­til the Brexit land­scape be­comes clearer.

Mon­e­tary pol­icy com­mit­tee

As ex­pected, the bank’s nine-strong mon­e­tary pol­icy com­mit­tee voted 7-2 to keep in­ter­est rates on hold.

How­ever, the bank said pol­i­cy­mak­ers be­lieved “some with­drawal of mon­e­tary stim­u­lus was likely to be ap­pro­pri­ate over the com­ing months” – its strong­est sig­nal of a rate hike yet.

Within min­utes, ster­ling had surged 1.5 per cent against the euro to be trad­ing at 88p, its high­est level in months, pro­vid­ing some re­lief for Ir­ish ex­porters, who have been in the eye of the Brexit storm.

In a TV in­ter­view later gov­er­nor Mark Car­ney added to the bullish fer­vour, sug­gest­ing the pos­si­bil­ity of a rate in­crease had def­i­nitely in­creased.

The bank and Car­ney have pre­vi­ously sig­nalled the prob­a­bil­ity of rate hikes ahead, only to be caught out by un­ex­pected changes in the economy, and yes­ter­day’s de­ci­sion doesn’t change the dif­fi­cult po­si­tion it finds it­self in.

With UK un­em­ploy­ment at a 40-year low of 4.3 per cent and in­fla­tion tick­ing up to­wards 3 per cent, con­ven­tional eco­nomic wis­dom calls for a rate hike to cool the economy and halt in­fla­tion.

How­ever, Bri­tain is also be­ing swept along by two un­usual rip tides, one pe­cu­liar to the UK and the other global.

The pe­cu­liar cur­rent is Brexit. If the bank ups rates and stymies con­sump­tion and in­vest­ment be­fore the full eco­nomic im­pact of the UK’s EU exit ma­te­ri­alises, it risks com­pound­ing the likely fall-off in eco­nomic growth.

Wage growth

The other more global cur­rent re­lates to wage growth. Nor­mally when economies tend to­wards full em­ploy­ment, wages be­gin to rise as em­ploy­ers chase a shrink­ing pool of labour.

How­ever, wage growth in the UK, the US and Ire­land, where job cre­ation rates have been strong, re­mains un­usu­ally slug­gish, con­found­ing the tra­di­tional eco­nomic par­a­digm.

Av­er­age wages in the UK are ris­ing at an an­nual pace of 2.1 per cent, but with in­fla­tion at 2.9 per cent, that means real wages are ac­tu­ally fall­ing, another rea­son for the Bank of Eng­land to be wary of rais­ing rates.

The fear is that if the gap be­tween in­fla­tion and wage growth gets too wide, con­sumer spend­ing – the en­gine of the economy, which has been rel­a­tively ro­bust to this point – will be­gin to slow, stalling eco­nomic growth fur­ther.

No­body seems to have a han­dle on why in­comes have been slow to rise.

It may be that the new jobs are poorly paid; or that young peo­ple are com­mand­ing less in­come. Per­haps firms are still nervy about lift­ing wages. Another the­ory is that there is sig­nif­i­cant un­der­em­ploy­ment in the new gig economy.

Ei­ther way, the Bank of Eng­land finds it­self on horns of a dilemma over in­ter­est rates.

Mark Car­ney added to the bullish fer­vour around ster­ling, sug­gest­ing the pos­si­bil­ity of a rate hike had def­i­nitely in­creased

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