Jonathan Marriott, Chief Investment Officer
The Federal Reserve’s (Fed) move to taper its quantitative easing programme was so well signalled in advance, that when announced it had virtually no impact. They are focusing on reducing bond buying before raising interest rates. On this side of the Atlantic, the Bank of England’s (BoE) failure to tighten monetary policy caused a sharp fall in gilt yields and the pound to weaken. Following statements from the Governor, Andrew Bailey, and other officials, the market had started to price in rate rises starting from this meeting. They continue to say that rate rises are getting closer but the Monetary Policy Committee (MPC) voted 7-2 not to move this time. The vote to keep the existing programme of government bond purchases at the same level was closer at 6-3. The additional vote to cut bond buying came from Catherine Mann, a new member on the MPC. Whilst they held off raising rates at this meeting, it is clear that they are ready to light the fuse with rates expected to rise in the coming months.
The BoE have raised their forecast for inflation and now expect it to peak at 5% in April 2022. Both the Fed and the BoE have been forced to admit that inflation is higher and more persistent than they had expected. However, they continue to see much of the inflationary pressures as transitory and related to the pandemic. At the press conference yesterday, the BoE stressed that much of the inflationary pressure came from rising gas, oil and electricity prices. Raising interest rates in the UK has little impact if the inflation is driven by international concerns and supply constraints. They indicated that they would be more concerned if wages start to rise faster than inflation threatening an upward spiral in prices. Without wage rises, higher prices constrain spending and as such demand falls, thereby reducing price pressures.
The bond purchase programme is almost complete, and the debate for now is whether to unwind the increase in the bank balance sheet or to raise rates. For now, it looks like rates will start to rise in the coming months, but the exact timing is far from clear. However, this is likely to be slow with the base rate remaining below 1% until the end of next year.
The Fed had carefully prepared the market for the tapering announcement, so it had little impact when it was announced. Many market participants had anticipated that the BoE was doing the same, hence the market reaction when the rates remained unchanged. Mark Carney was referred to as an “unreliable boyfriend” when he was perceived as giving misleading indications, Andrew Bailey, his successor as Governor, seems to have inherited his title.
During the pandemic central banks provided unprecedented support for the economy and financial markets. However, they now need to take back some of this largess. They should aim to do this, as the Fed have successfully done so far, without disrupting markets. The BoE will need to follow its words with actions in the coming months if they want to keep their credibility. Equally to cause a tightening when the Government is already raising taxes and energy prices are increasing could have an adverse effect on the fragile economy. Andrew Bailey and his fellow MPC members will have a fine balancing act in the months to come. Despite no action this month some tightening remains on the cards.
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