BoE Deputy Governor Gives Crazy Speech Warning Markets Have Underestimated Rate Rises

On 2 November 2017, the Bank of England raised rates for the first time in a decade and Sterling’s initial rise was promptly sold off by forex traders as we discussed.

The 7-2 vote by the Monetary Policy Committee was not the unanimous decision some had expected, while Cunliffe and Ramsden saw insufficient evidence that wage growth would pick up in line with the BoE’s projections from just over 2% to 3% in a year’s time. Ben Broadbent, MPC member, deputy governor and known to be a close confidant of Governor Carney, gave a speech today at the London School of Economics (LSE) in which he warned markets that Brexit issues didn’t necessarily mean that interest rates have to remain low.

Bloomberg reports that Broadbent stated that the Brexit impact on monetary policy depends on how it affects demand, supply and the exchange rate.

"There are feasible combinations of the three that might require looser policy, others that lead to tighter policy."

Which sounds alot like he doesn"t know, although he stuck to the central bankers trusty tool, reassuring LSE students the Phillips Curve "still seems to have a slope".

According to the FT.

The deputy governor of the Bank of England has warned that financial markets have underestimated the chance of further interest rate rises. In a speech at the London School of Economics on Wednesday, Ben Broadbent said markets had placed too much emphasis on the idea that interest rates needed to be kept low in the face of Brexit uncertainty. The deputy governor said it was “uncertain” and “complex” to anticipate how Brexit would affect inflation. But he rejected the assertion that Brexit “necessarily implies low interest rates”.

 

“Even as inflation rose, and the rate of unemployment fell further, interest-rate markets continued to under-weight the possibility that (the) bank rate might actually go up this year,” he said.

 

The BoE’s Monetary Policy Committee announced its first interest rate rise in more than a decade earlier this month. But the central bank has struggled to convince financial markets that it is likely to raise rates further.

 

BoE officials were taken aback when sterling sold off on the day it announced the rate rise, and two-year gilt yields remain below the BoE base rate, suggesting markets are sceptical that the MPC will raise rates further while there is still considerable uncertainty around the UK’s economic future outside of the EU.

Broadbent acknowledged that there is a risk that Brexit uncertainty could adversely impact UK demand. However, he sees the potential for other factors, a reduction in trade, for example, which could crimp UK capacity and necessitate a rise in rates. While Broadbent’s thinking is flawed, and his barley field example plainly ridiculous, the FT continues.

Brexit-related uncertainty could weigh on demand and motivate the MPC to keep interest rates low to support the economy, but other factors could push the central bank to raise rates.

 

For example, if Brexit reduced the UK’s openness to trade, the country’s output capacity could suffer, which would require the BoE to raise rates to temper inflation.

 

“Economists often presume that changes in an economy’s underlying productivity occur only slowly,” Mr Broadbent said. However, he added: “A sharp reduction in the degree of openness (to trade) could have a more immediate impact. “A field currently producing barley, sold into the European market, can’t easily or as fruitfully be replanted with olive trees”. He said the challenge for monetary policymakers was that “reductions in supply can add inflationary pressure even as they lower aggregate (gross domestic product)”.

So, let’s consider Broadbent’s example...

The UK suffers a drop in aggregate demand due to a contraction in trade, the BoE raises rates in an over-leveraged economy to stem the inflation and…undoubtedly makes the contraction in GDP much worse. That makes no sense and is the kind of one dimensional thinking that we’ve had to put up with from central bankers. What’s worse is that Broadbent has specific responsibility for monetary policy and a c.v. as long as your arm – Cambridge, Harvard PhD, Fulbright Scholar, Columbia University, Goldman Sachs and UK Treasury.

It’s no wonder we are in such a mess with people like this pulling the levers of policy in the central banks. Crazy ideas aside, Broadbent and his BoE colleagues might be unhappy with market projections for the future path of interest rates, but they can hardly blame investors for being sceptical.

Which way are rates going, Ben?

 

Why China Unexpectedly Hiked Rates 10 Hours After The Fed

As we reported on Wednesday evening, something interesting took place on Thursday morning in Beijing: in a case of eerie coordination, China tightened monetary conditions across many of the PBOC"s liquidity-providing conduits just 10 hours after the Fed raised its own interest rate by 0.25% for only the third time in a decade.

The oddly matched rate hikes, prompted Bloomberg to think back to the mysterious "Shanghai Accord" of February 2016, which took place during the peak days of last year"s global capital markets crisis, and whose closed-door decisions - to this day kept away from the public - prompted the market rally that continues to this day. As Bloomberg wrote, the coordinated "response suggests that pledges by the Group of 20 economies a little over a year ago in Shanghai to "carefully calibrate and clearly communicate" policies may not have been hollow after all."

That said, it was not the first time the People’s Bank of China has acted on the heels of a Fed move. At the peak of the financial crisis, the PBOC cut lending rates after six of its counterparts, including the Fed, had announced a simultaneous rate cut. That October 2008 move enhanced China’s emerging reputation as a global player on the international economic-policy circuit. “Growth divergence is morphing into growth synchronization," said Chua Hak Bin, a Singapore-based senior economist with Maybank. "Policy divergence was also a narrative for those expecting a strong dollar, but that is moving now to policy synchronization.”

Coordinated or not, as of last night financial conditions in China, like in the US, have become incrementally tighter even if both the Chinese and US stock markets failed to respond accordingly.

So, for those curious what China did - after all the days of shotgun Interest rate or RRR moves appear to be on hibernation for the time being - here is a convenient primer from SocGen"s Wei Yao explaining not only the mechanics, but the reason why.

As Yao notes, the PBoC followed the Fed closely, at least timing-wise, and raised the rates on its major liquidity management tools by 10bp across the curve today, earlier than many had expected. After the hikes, the rate on the 7D reverse repo operations - the most critical of all - is now at 2.45%.

The central bank, in its press release, stressed that these interbank rate hikes simply follow the market"s development, thus not true policy rate hikes, and only hikes of benchmark lending and deposit rates count. Nevertheless, it also listed four classical rate-hike reasons for the interbank rate changes: the economic recovery, rising inflation (particularly that of housing), strong credit growth and Fed"s rate hikes.

SocGen"s interpretation of this statement is:

1. The PBoC is responding to the fundamentals of growth, inflation and financial stability. And it is looking through the low food prices, which have suppressed CPI, and paying due attention to domestic asset bubbles and credit growth.


2. But it still prefers a tightening approach so as to match its neutral stance, which means that adjusting interbank liquidity and interbank rates will likely remain the main actions. This may be because the headline CPI is muted after all, or because it has to change its policy rates from benchmark deposit/lending rates to interbank-linked rates sooner or later and so better start practicing now. In any case, it does not want the market to get ahead itself and price in too much tightening, just like the Fed.


3. Fed"s policy and US-China interest rate differentials do play a role in PBoC"s consideration. It may not be a very big role, as offering 10bp for every 25bp from the Fed is at best half-hearted help to the RMB. However, the Fed"s action offered the PBoC a timing to make the move, appearing to support the argument that the interbank rate hikes are “following the market”.

Given PBoC"s latest move and our view that growth stability will stay until the end of 2017, SocGen now expects further interbank rate hikes: 20bp in 2Q, 10bp in 3Q and no change in 4Q.

The equally critical development to watch is the evolution of interbank market rates as resulted from PBoC"s daily liquidity management. The trend of these market rates leads the changes of rates on PBoC"s instruments, thus a more timely indication of PBoC"s intention. Before today"s moves, the 28-day moving average of the 7d repo was already 50bp above the low back in August 2016.

Finally, while China has traditionally shied away from criticizing the Fed using conventional channels, in a surprising editorial in the Economic Information Daily, the authors said that China should be wary of a "spillover effect" from the Fed rate hikes, warning that “selfish” US interest rate policies have historically triggered crises in many other nations, the newspaper says in its front-page commentary. Finally, it warned that frequent Fed rate hikes may have “serious impact” on global economy.

Keep a close eye on tonight"s reverse repo facility: if China is really concerned, it very well may "hike" again.